Although there have been concerns over the lacklustre performance of environmental, social and governance funds this year, analysts believe this is temporary and will not lead to a decline in longer-term support for sustainability trends.
This is because investors remain committed to net zero emissions goals and sustainable investments as well as holding companies to account for their ESG credentials.
There is no doubt though that to date, 2022 has been challenging. Research from Investment Metrics, an investment analytics provider., shows that in the second quarter, the median return for its global ESG equity peer group was -15.6%, six basis points better than the MSCI ACWI index.
However, for the first half of 2022, 78% underperformed the benchmark, with the median underperforming by 2.5 percentage points.
The firm studied 52 funds from 45 asset managers in a global ESG equity peer group created by screening the broad IM global equity peer group for products branded or focused on ESG.
The report also showed that 80% of global ESG equity products outperformed over three years, with a median return of 8.5%, outperforming the benchmark by 2.3 percentage points and the broader global large cap equity peer group by 1.2 percentage points,
In general, it noted that global ESG equity products nearly doubled in assets from 2019 to 2021, and most outperformed until 2022.
From 2019 to 2021, assets soared 98%, with net inflows of $25 billion in 2020 and $35 billion in 2021. By contrast, outflows for global large-cap equity products dominated over the past eight years, including $100 billion last year.
In addition, over half or 55% of global ESG products are based in Europe, excluding the U.K., and 60% are broadly focused on sustainable products, 30% on the environment and 10% on impact or social themes, according to the report.
Drilling down into performance, aseparate study from Federated Hermes’ global equities team revealed that environmental factors have become a statistically meaningful driver of shareholder returns over the past two years.
The team, which has been conducting research every other year since 2014, assesses how E, S & G contributes to performance.
It said that investors can capture the ESG premium by avoiding the ESG laggards as well as those companies whose standards are slipping. The exception are real estate and energy “where companies in these sectors with the worst or worsening environmental practices relative to peers tended to outperform,” it says.
Federated Hermes’ inaugural ESG research, published in 2014, revealed that the relationship between governance and shareholder returns to be ‘non-linear’.
It said that companies with leading or improving corporate governance scores outperform peers with poor or worsening standards – but rather than performance deriving from the leaders outperforming, the governance premium is largely driven by the underperformance of the laggards.
In its 2020 research, the firm said that the Covid-19 pandemic highlighted the importance of social impact, with more socially responsible companies tending to outperform.
Previously there was weak evidence that environmental factors had similar properties, but the historic relationship was volatile and did not reach the necessary hurdle to be considered significant.
That has changed over the last two years, with environmental factors supporting performance on a par with social and governance. ‘This confirms that across the environmental, social and governance pillars, the link between ESG and performance is clearly in evidence,’ according to the study.
Lewis Grant, senior global equities portfolio manager at Federated Hermes, says some investors will just avoid the entire real estate and energy sectors in the name of environmental considerations.
He says, “Does this exclusion by many sustainable investors result in the sector being more influenced by those less concerned by sustainability?” he asks. “And if sustainability-focused investors are not acting as stewards of the energy sector, it may be asked: who is?”
The firm notes that awareness of sustainability continues to grow across every sector, Federated Hermes says. Embracing sustainability in general is not just about avoiding risks, but also about finding business opportunities.
Grant adds, ‘We stand by the belief that sustainability requires a long-term focus and can deliver the opportunity for long-term results. In the developing environment, we believe businesses with the right longer-term focus will be the ones that thrive.’