Even though environmental, social, and governance (ESG) investing still constitutes a small slice of the global stock market, investor appetite is growing rapidly, nonetheless. In fact, a recent Financial Times article notes that statistics from EPFR reveal ESG-focused equity funds alone have taken in $70 billion of assets over the past year, while traditional equity funds have witnessed $200 billion in outflows during the same timeframe.
ESG is becoming more and more popular in the investing world as more investors are starting to ask the question, what types of companies am I investing in. That said, investors more and more concerned about putting their money where their values are in that regard. For instance, these investors may not want to invest firms that pollute the environment or are against certain issues that they believe in.
In the ESG investment space, I think that we’re going to start seeing a separation of the three areas for investment purposes: “E” for environmental, “S” for social, and “G” for governance. That’s why, for example, our investment strategy focuses entirely on the “E” part of the equation (the environment). Toward that end, we look to invest in companies that are environmentally friendly in some way, shape, or form. These are not necessarily companies that just deal in producing clean water or energy, but companies that through their policies support the fact that they are helping the environment through issues such as preventing global warming.
As the whole ESG industry shakes out and matures, I think you’re going to see more and more of niche investing whereby funds will focus either environmental, social, or governance. This will allow investors to decide which of three factors in ESG is the most important to them versus having to invest in all three areas.
Another reason why this is important is that society in this regard is changing and more and more investors are starting to ask the question: what are the companies in my portfolio? As a result, portfolio managers are going to be forced to start looking for companies that are more focused on these ESG factors. Fund managers have adopted several approaches to solidify their commitment to ESG. This includes ramping up research, integrating ESG considerations across asset classes or adding ESG-dedicated funds that cater to specific investor preferences. Many use both internal research and external ESG data to determine whether certain holdings belong in their portfolios.
What that’s going to end up doing is two things. Number one I think that it’s going to change the world where more and more companies are going to have to start looking at their policies and trying to do something along the lines of helping society.
The second thing that it’s going to do is make ESG a factor from the standpoint of companies that are friendly in some way shape or form — E, S, or G or all three — are going be more bid up in the marketplace. Another words, investors are going to be willing to pay a premium for those companies and this will help the performance of funds that invest in that space.
The performance aspect is extremely important when people think of ESG because for many years socially responsible funds really lagged in performance. When investing in the space, investors use to have to choose between putting their money where their values are versus giving up the potential for substantially higher returns.
Going forward, portfolio managers in this space really needs to focus on the return aspect. If we can give investors the opportunity to earn the similar or better returns than other things out there, then ESG becomes a no-brainer. If you’ve got a fun that’s doing just as well as another fund but is investing in companies that are friendly to one or more of these areas of ESG, then investing in the ESG friendly fund becomes a no-brainer. One of the ways that makes what we do unique in this space is “tactical” investing. So, the combination of environmentally focused stocks that give the investors the opportunity to beat the market along with the downside protection of tactical is the optimal investment formula that we’re trying to produce in this space.