Investing with environmental, social and governance (ESG) considerations is perhaps the closest thing to a chimaera in the financial sector. By taking non-financial disclosures into account, various participants in the investments sector can shape and reshape the broad label into nearly anything that is fit for purpose.
For example, Amundi, Europe’s largest asset manager, refuses to exclude weapons entirely from its investment universe. Chief investment officer Vincent Mortier says this is in line with the firm’s policy “because we believe that each sector has a role to play”. As a result, the firm’s strategies outperformed those of its peers when Russia invaded Ukraine in 2022.
Amundi’s global responsibility investment policy has set some exclusions on weapons, coal and oil and gas, but “if an alternative at scale doesn’t exist, just excluding, it doesn’t work; it’s not realistic”, says its chief responsible investment officer Elodie Laugel. “We should then play our active shareholder role and engage with companies.”
In our line of work as journalists, we have seen and heard of more creative applications of such green labels at the grassroots level.
Installing bicycle racks at the foot of an office building is said to encourage “low-carbon commuting”. High-grade air filters in new developments are talked up to be as important as energy-efficient heating, ventilation and air conditioning (HVAC) systems. Invitations to tree-planting corporate social responsibility (CSR) events have thankfully slowed to a trickle.
See also: Investing for impact? Learn these lessons from ESG investing
This is not to knock on the importance of such small initiatives, but when they are launched by large — sometimes listed — companies, it becomes obvious that these programmes are hardly needle-moving compared to their operations, and much more can be done.
To retail investors, these concessions may continue to limit their understanding of ESG investing and sustainability initiatives.
So, what is the state of mainstream ESG investing today, and how has it evolved?
See also: A US$12 bil climate fund is readying a rare bond issuance
The Edge Singapore dug into the history of ESG investing for our 1,000th issue in September 2021 (Issue 1000: “ESG: Doing good, and we’ve been doing it a while”), around the peak of the pandemic-era exuberance for ESG-related funds and strategies.
Regulators began cracking down on “sustainable” labels by end-2021 (Issue 1016: “A reality check for ESG investing”), and by mid-2022, the pullback had spread to the bond market (Issue 1046: “ESG investing: Losing steam or teething problems?”).
Globally, the value of green, social, sustainability and sustainability-linked (GSSS) bonds issued peaked in 1Q2021 — although 2Q2023 saw comparable values that also represented a larger share of the global bond market.
For 4Q2023, the ESG investing space even notched fund outflows. Global sustainability fund inflows declined 68% over 2023 to US$60.2 billion ($81.4 billion) and notched a US$3 billion net outflow in 4Q2023, say Maybank Research analysts Jigar Shah and Neerav Dalal.
Citing Morningstar data, 2023 marked the second year of declining fund inflows after peaking in 2021 at US$620 billion, they add.
For a sector that is so focused on the future, what are some myths that are weighing on investor interest? Planet Edge by The Edge Singapore debunks three myths about ESG investing.
To stay ahead of Singapore and the region’s corporate and economic trends, click here for Latest Section
Myth #1: ESG investing is only for impact
Financial investment has always been about trying to understand which companies are “fit for the future”, says Thomas Höhne-Sparborth, head of sustainability research at Lombard Odier.
“Today, we talk about sustainability, but it is really a mindset of asking ourselves what companies are well-prepared for major economic disruptions, and at its core, that is what investors have always or should always have been thinking about,” he adds. “The only thing that has changed is that the environment and environmental policy has become a new driver of major economic change.”
The markets are “missing a point” if they approach sustainability merely as a “hygiene check”, says Höhne-Sparborth, who is based in Switzerland. Instead, understanding the nature of sustainability drivers can help uncover new opportunities. “The sustainability transition will shift markets and profit pools, and the companies that will succeed are those that are developing strategies well-adapted to this new economy, both in how they operate and the sources of return that they target.”
These businesses are simply more “fit for the future”, he reiterates, not only because they are more resilient, but also because they are more “resource-efficient and, as a result, economically efficient”.
“The reason why we think solar power is going to be a major source of energy for the planet is not only because it has a lower environmental footprint; it’s because it’s the cheapest form of energy on the planet today,” says Höhne-Sparborth.
Solar power has benefited from “tremendous” economies of scale, he adds. “It’s a tremendously modular technology. Eventually, the marginal cost [will] go to zero, [and it] is a non-depleting asset.”
Höhne-Sparborth believes the energy transition towards a “non-depleting” energy source is underappreciated by many. “Renewable sounds great environmentally; it sounds even better economically. You have a renewable source of power, a renewable source of income.”
Myth #2: ESG investing is costlier
Morningstar Sustainalytics tackles this myth head-on in a new report, claiming that costs have actually declined in recent years.
The asset-weighted costs for ESG funds in six of the most popular Morningstar categories in Europe average 0.83%, compared with 0.90% for conventional funds. These were 1.55% and 1.32%, respectively, a decade ago.
The June 24 report by Morningstar Sustainalytics referenced a sample of over 110,000 retail share classes from over 37,400 funds domiciled in Europe, including about 4,000 ESG funds. The six popular Morningstar categories represent more than 70% of the European ESG fund universe.
According to the findings, active ESG funds exhibit lower costs than their conventional peers in five of the six selected categories, as measured by asset-weighted and simple averages. Passive ESG funds, meanwhile, tend to be on a par with their non-ESG equivalents in four of the six categories, on an asset-weighted average basis.
Emerging markets is the only category where passive ESG funds exhibit notably higher expenses, with costs of 0.24% versus 0.19% for its conventional peers. However, the 0.05% gap remains “modest”, say analysts.
Investors have been “led to believe” that ESG-focused funds are more expensive than conventional funds, says Hortense Bioy, head of sustainable investing research at Morningstar Sustainalytics. “While there is undoubtedly a wide range of ESG strategies with various price tags out there, we found that, on average, ESG funds don’t charge more than non-ESG funds. This is mainly due to the proliferation of new products and growing competition in the ESG space in recent years.”
Newly-launched ESG funds have tended to charge lower fees than their conventional peers, according to Morningstar Sustainalytics, but the story is more nuanced for passive ESG funds. “While on a simple average basis, newly-launched passive ESG funds tend to charge less than their new non-ESG counterparts, this is not always the case when looking at asset-weighted averages. In five of the six selected categories, the asset-weighted average costs for passive ESG funds incepted in recent years have been higher than those for their passive non-ESG peers.”
This suggests that most of the passive money has been flowing into the “cheapest” new funds and share classes, which tend to be “non-ESG, plain vanilla ETFs”, note the analysts.
Myth #3: Hype for ESG investing is over
2021 and 2022 were “exceptional years” that saw “massive” fund flows into ESG-related funds, a result of new distributors unlocking such strategies for the retail market, says Amundi’s Laugel.
But the energy crisis in Europe following Russia’s attack on Ukraine saw “a lot of rotation” from equity into fixed income, she adds. Hence, fund inflows fell.
Fund flows into ESG may have fallen in magnitude between late 2022 and 2023, but this is a “normalisation”, adds Laugel. “We should not draw a conclusion that there is less appetite.”
An April report by Morningstar claims the global universe of sustainable open-end funds and ETFs rebounded slightly in 1Q2024 by attracting nearly US$900 million of net new money, compared to net outflows in 4Q2023.
European sustainable funds registered almost US$11 billion of inflows, more than double the subscriptions of the previous quarter.
In contrast, the US experienced its worst-ever quarter with record redemptions of US$8.8 billion.
Total assets in sustainable funds across Asia ex-Japan were roughly flat, increasing 1.6% over 1Q2024. Outside of China (where Morningstar could not get data), Taiwan “continued to be far and away” the largest market in the region with 24% of assets, says Morningstar.
Singapore-domiciled sustainable fund assets fell 3.8% q-o-q. iShares MSCI Asia ex Japan Climate Action ETF, the largest sustainable fund in Singapore at US$436 million in assets as of end-March, shed US$31 million despite its underlying index returning 0.9% over the quarter.
Equity funds remained the largest asset class in the region at 67% of Asia ex-Japan sustainable fund assets as at end-March, while allocation and fixed income funds accounted for 22% and 11%, respectively.
From January to March, there were eight new sustainable funds launched across the Asia ex-Japan region, the lowest amount since 4Q2019. Five of the new launches were China-domiciled products, two were Taiwan-domiciled and one was in South Korea.
Has the hype train for ESG investing truly passed? Investor interest appears to be returning, while the returns are painting a stronger picture.
Over the past decade, there have been periods of time when sustainable portfolios have outperformed an unconstrained portfolio, says Emily Petersen, portfolio director at Schroders. “This is consistent with our view that longterm outcomes for the two strategies are likely to be broadly similar, even if the journey looks very different.”
The most commonly cited barrier to adopting a sustainable investment approach is concern over sacrificing financial returns, notes Petersen, but there is “little conclusive evidence” as to whether sustainable strategies generally outperform or underperform their more traditional peers.
She cites challenges around classifying sustainability labels and “comparatively short” track records. For example, the MSCI All Countries World Index ex Fossil Fuel index, which excludes fossil fuel companies, has outperformed the unrestricted MSCI ACWI over one, five and 10 years to end-2023.
“It is only over three years that the unrestricted indices have outperformed. This is despite the spike in energy prices following Russia’s invasion of Ukraine, which has seen bumper profits for energy companies over the last two years,” notes Petersen.
The modern ESG investor
Europe may appear to be at the forefront of sustainability labels and regulations, but one survey says investors in Asia are more likely to hold “ethical or ESG funds” in their portfolios than their counterparts in Europe.
According to AXA Investment Managers’ ESG Investing: A Global Investor Study 2023, Indonesia leads Asia, with 51% of investors surveyed already invested in ESG funds. In total, 12,000 respondents in 12 countries shared their thoughts for the biennial survey.
Interestingly, investors in Japan and Singapore were among the least likely to expect an ESG fund to outperform the market, while those in Indonesia (48%) and Thailand (63%) were most positive on potential ESG fund performance.
Attitudes may also be changing among institutional investors. Last year, Stanford University and the MSCI Sustainability Institute surveyed institutional owners and asset managers, nearly half of whom manage more than US$250 billion in assets, on their views on sustainable investing.
Nearly two-thirds (63%) of institutional investors revealed that ESG considerations offer a more holistic view of a company’s risk to support better-informed decisions. Most institutional investors (80%) believed ESG has an impact on the financial performance of an investment, and that ESG performance is industry-specific (77%).
Notably, only 37% believed ESG generates alpha, while 20% believed ESG does not impact financial performance at all.
Retail investors’ investment decisions are less agnostic. They are influenced by a multitude of factors, ranging from personal values, ethical considerations to financial returns, says Wang Xiaoshu, head of APAC ESG and climate research at MSCI.
“MSCI has developed a comprehensive series of sustainability metrics, offering a broad set of standardised data and simple metrics that are comparable across a wide universe of companies,” says Wang. “The availability of such detailed sustainable metrics at the fund level through wealth management platforms allows retail customers to make informed decisions, aligning their investments with their personal values and risk preferences.”
The rise of transition finance has also muddied the waters — but for the better. Investments in energy projects, for example, are no longer separated into the dichotomy of “ESG” and “non-ESG” buckets.
Instead, financiers are now cautiously funding projects like coal-fired power plants, but with a caveat that they must shut down by a certain number of years.
A HSBC-funded paper released last month even suggested “repowering” coal plants for use as grid interconnectors or renewable energy sites, citing a limited number of examples in Poland and the US.
Such developments continue to blur the lines between different investment themes; investing for a better planet may one day be as ubiquitous as investing itself.
