ESG Investing: Growing Popularity In Focus

Summary

• ESG investing has experienced a recent surge in popularity.
• The pandemic has offered an opportunity for ESG to show a strength seen previously during the GFC.
• Some of the factors that might lead to the sustained growth of ESG fund inflows are considered.

ESG (Environmental, Social, and Governance) investing is socially conscious investing. Why should investors care about that stuff mid-pandemic? This article takes a look at the current state of ESG investing, how are funds holding up, and how do performance trends compare to previous eras.

What is ESG and why consider ESG?

ESG is let's generate a return on our investment without making the world a worse place. The actual aim is financial; companies that engage in questionable practices are a risk to the performance of a portfolio. Despite the financial goals, ESG investing is still commonly viewed as investing with social goals in mind.

The market has had a bit of a rough ride in 2020 although the SPDR S&P 500 Trust ETF (SPY) is currently up about 5%, it was down 30%+ at one point in March. However, even if you're not a tree-hugger, anti-coal, or anti-war, ESG investing can be a way to outperform the market following a downturn. For example, looking back to the era of the GFC, MSCI's EM ESG (ESGE) index did outperform a relevant benchmark.

Looking over the longer term, the performance results of ESG funds seem to vary based on who is performing the analysis and how. The results are hardly unequivocal. It isn't hard to find studies suggesting ESG funds do not outperform. Looking a little more recently, however, there are many analyses suggesting that ESG funds have outperformed or "shined" during the COVID-19 crash.

Figure 1: Snapshot as of April 10, 2020, of a number of ESG funds outperforming the S&P 500. Similar analyses by different sources note similar trends. The performance of Brown Advisory Sustainable Growth Fund Institutional Shares (BAFWX) continues, up 22% year-to-date at the time of writing, and similarly for the Nuveen Winslow Large-Cap Growth ESG Fund (NVLIX), up 24% YTD. Source: S&P Global article.

The popularity of ESG investing

In terms of search trends, the popularity of ESG investing has increased over time, and right before the recent sell-off, it really seemed to be generating broader appeal. A recovery has happened in more recent months in search trends.

Figure 2: In the upper panel, results from a Google Trends search for "ESG investing." The note between 2013 and 2016 in the upper panel says that "An improvement to our data collection system was applied from 1/1/16." As such is maybe ideal to focus on data after that point (2016 onward). The lower panel provides a focus during the past five years, including a comparison to the search term "tobacco stocks" in red. Source: Google Trends.

While the popularity of ESG investing continues to surge, there are still plenty of detractors out there. In February, Venture capitalist Chamath Palihapitiya, referred to ESG investing as a "complete fraud" on CNBC although his concerns relate to the goals of those considering ESG policies. Specifically, Palihapitiya argues that the motive of JPMorgan Chase & Co. (JPM) regarding ESG is simply to get the benefit of being able to borrow money from the European Central Bank at negative rates.

In terms of fund inflows, the popularity of ESG is higher than ever. Any publicity is good publicity it seems, as inflows into ESG funds have strengthened substantially in 2020. Most analyses look at Q1'20, but with Q2'20 data also doing the rounds now, it can be seen that the trend of inflows has held up.

... UK fund flow data from transaction network Calastone found that the amount of new money invested in ESG equity funds between April and July exceeded the combined flows for the previous five years.

Financial Times article by Siobhan Riding, August 2020.

Figure 3: Outflows from traditional funds throughout Q1'20 were not mirrored in ESG funds, where inflows have been seen. Source: Morningstar analysis cited in Raconteur article by Marina Gerner.

Thoughts on the road forward

I see two factors that will continue to grow the popularity of ESG investing. Firstly, millennial investors, who stand to inherit more than $30T from the Baby Boomers in the coming decades, are more likely than non-millennial investors to seek out companies with high-quality ESG practices. That being said, other generations might continue to contribute to fund inflows themselves.

Currently only 17% of millennials are participating in ESG investing (compared with Gen Xers at 7% and boomers at 3%), yet nearly half of Gen Xers and boomers say they are interested in having some money in ESG investments at 49% and 47%, respectively.

Results from a sentiment study by Allianz Life reported August 2019.

Secondly, the pandemic isn't over. The performance of ESG funds during the pandemic has brought them onto the radar of many who may previously have not been too concerned with ESG investing. I think ESG investing will remain in focus throughout 2020 with fund inflows continuing to be strong.

What can we do with this information? Personally, I see three options. The first option would be to consider being prepared for any sell-off with a potential shortlist of ESG funds to dip into. Some of the best ESG funds considering one-, three-, and five-year performance up to year-end 2019, according to an analysis at Bloomberg are worth a mention. The top 5 performers were: The Morgan Stanley Institutional Fund, Inc. Global Opportunity Portfolio (MGGPX), Brown Advisory Sustainable Growth Fund Investor Shares (BIAWX), Morgan Stanley Institutional Fund, Inc. International Opportunity Portfolio (MIOPX), Calvert Equity Fund Class A A (CSIEX), and The Ave Maria Growth Fund (AVEGX). Past performance doesn't guarantee future gains, it should be noted, and considering the holdings of the funds is an obvious step for those who care not only about performance but also the socially responsible aspect of ESG.

A second option is to consider ESG funds now. For those who hold some of their portfolio in funds, perhaps to reduce volatility, a simple substitution of MGGPX for SPY might be an example.

A third option is to eschew ESG investing and lean into your inner sinner. An obvious option in this space is the AdvisorShares Trust - AdvisorShares Vice ETF (ACT).

Authors note: I have kept potential options on ESG investing very brief for a reason, these comments do not represent investment advice.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.