December 2019
A Look Into ESG Funds
By Tim Courtney, Chief Investment Officer
Over the last decade, environmental, social and governance (ESG)1 funds have become increasingly popular as more and more investors look to align their money with their personal values. Investors can now screen and select companies based on multiple factors.
There are endless ways to construct ESG portfolios and the number of funds available in the ESG space has continued to proliferate over the last 10 to 15 years. Additionally, the assets that qualify for inclusion in these strategies are increasing, with one report showing that sustainable investment assets have grown 34 percent since 2016.2
One interesting development with ESG funds is that the performance of these funds seems to have been strong over the last several years, which is why we decided to take a closer look at the space and recent returns.
Back in 2016, we conducted a major analysis on these funds and the returns weren’t inspiring. The vast majority had underperformed the broad markets, in many cases by a meaningful amount over 5- and 10-year periods. The fund set we reviewed was relatively small however, since many ESG strategies had only recently started and didn’t have a decade’s worth of performance available.
We finished the study with a limited number of ESG funds that met our criteria and that we would recommend to clients interested in the space. Since then, however, there are more years of data to review and many more strategies available now that ESG assets have nearly tripled over the last decade.3 In addition, performance reviews of the space indicate that many of the strategies’ returns have begun to match or even outperform the market.
In reviewing ESG funds, there are some interesting reasons why we believe recent performance has improved significantly from previous numbers. First, many of the funds have greatly reduced or have no exposure to the energy sector, which has been an underperformer over the last several years.4 Second, many have higher-than-average exposures to the technology sector, which tends to have relatively “clean” business practices and avoids issues with pollution, fair trade, human rights, etc. Tech companies also happen to be wrapping up a fantastic five-year stretch.5
Our takeaway from the study is that the ESG performance over the last few years is at least somewhat due to the sector allocations of the funds. An issue of risk here is that tech companies may be subject to higher regulation and greater scrutiny moving forward.
ESG funds are valid investment strategies that often are well-defined, have good diversification and reasonable costs. However, the recent performance may have more to do with how the tech sector has performed rather than the fund’s strategy mandates. If you have any questions or are interested in ESG, call your Exencial advisor and we’ll be happy to go over our recommendations.
Sources:
1. Investopedia – Environmental, social, and governance (ESG) criteria
2. Global Sustainable Investment Alliance – 2018 global sustainable investment review
3. CNBC.com – ‘Sustainable’ investors match the performance of regular investors, new IMF research finds
4. MarketWatch – S&P 500 energy sector index
5. CNN Business – Market sectors – Information technology
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