Funds focused on environmental, social and governance (ESG) issues were resilient during the coronavirus market sell-off—even as the overall fund universe saw massive outflows.
In the first quarter of 2020, the global sustainable fund universe saw inflows of $45.6 billion into both mutual funds and exchange traded funds (ETFs), while the overall fund universe posted $384.7 billion in outflows, according to Morningstar.
"During the worst of the market turbulence, the SRI ESG (socially responsible investing/environmental, social and governance) equity funds had only one week of outflows," said Cameron Brandt, director of research at Informa’s EPFR, a Boston research house (Informa is also the parent company of Wealthmanagement.com.) That was the first week of negative flows in these type of funds in over a year, he said, and ESG bond funds, after a slightly rougher passage, “emerged by setting a new weekly inflow record,” Brandt said.
At the end of March, global sustainable funds held $841 billion in assets under management, down 12% from the $960 billion in December thanks to the drop in the market. Still, these funds overall performed better than the global fund universe, where assets fell by 18%, said Morningstar.
The U.S. saw first-quarter flows in ESG funds grow 23% to $10.5 billion. ETFs alone made up $7.5 billion of the first quarter flows and $12.7 billion year to date, according to Bloomberg. About half that ETF money went into just one fund, the iShares ESG MSCI USA ETF (ESGU), said Bloomberg.
Ending the quarter down 19%, year to date the iShares fund is off by 5% (as of May 26) versus the negative 6.5% in the S&P 500, said Morningstar.
First quarter U.S. fund flows exceeded the quarterly record set in the fourth quarter of 2019. Passive funds received 80% of the flows, up from last year's 60%, said Morningstar.
Brandt said that cynical colleagues call the ESG designation as effective as pixie dust—but they have proven their value during a time of economic and business challenges. "This is a transitionary time," said Brandt, "where ESG SRI funds are in a position to shine."
A lot of people have noticed that not having as many airplanes in the sky and cars on the road leads to cleaner air, said Marc-Olivier Buffle, senior product specialist at Pictet Asset Management. Based in Geneva, Switzerland, Pictet has been investing thematically since 1995 and has $41 billion invested in this area.
"There are some regions of the world where you can suddenly see the mountains where you couldn't in the past because of the smog effect," added Buffle. "This is leading to a global realization and that is directly playing into the hand of those businesses that we invest in, ones providing solutions to those issues."
Europe's first quarter flows surged 72% to $33.1 billion. Total assets in U.S. sustainable funds jumped 14.3% to $119.3 billion and soared 81.7% in Europe to $683.9 billion, according to Morningstar.
"The pandemic is shining a spotlight on ESG considerations for companies around the world," said Martin Jarzebowski, director of responsible investing at Federated Hermes, a Pittsburgh-based firm managing $600 billion of global assets. He said in the current market multiple sustainable-investing and ESG-labeled funds are navigating the downturn better than their conventional counterparts.
"One thing you find is .... everyone wears different lenses. What's impactful to somebody might not be impactful to somebody else," said Jennifer Tonda, director of institutional trading at 280CapMarkets, a San Francisco cloud-based trading platform for fixed income markets called BondNav. "On the fixed-income side, we are seeing more social and sustainable bonds come to market."
Some investors are surprised ESG-focused strategies are now outperforming the general market, said Brandt. Most significant is the relative equivalence of performance between ESG funds and investments, and their non-ESG peers. "There's been a convergence in performance going on for the better part of 18 months. Even before the end of last year, there was no real trade-off to investing in green versus investing in standard funds."
Brandt added that the current pandemic will be the catalyst for fresh innovations in the ESG space because the investor community is beginning to realize the benefits to approaching the markets with, broadly speaking, a sustainability lens.
Jarzebowski said there's a new consistency of quality factors among ESG leaders, such as lower volatility and a higher profitability of their business models, one reason ESG funds could be outperforming. He added that taking structural ESG considerations into a normal investing framework is a new form of risk management.
"It's surprising to a lot of people that I speak with that doing good is actually doing well from a returns standpoint," said Jarzebowski. "People very quickly have forgotten that they also outperformed in the downturn of the fourth quarter of 2018. I think what's actually emerging here is ESG has more semblance of being the new quality factor."