ESG Funds: What Are They and Why Are They So Popular in Today’s Market?

ESG Funds: What Are They and Why Are They So Popular in Today’s Market?

            In this blog I wanted to highlight the growing popularity of environmental, social and governance (ESG) funds and some of the reasons for this. Their precursor, Socially Responsible Funds (SRI), were introduced over 10 years ago as interest in social issues grew with investors. Though as a fund class, they were not particularly successful in regards to performance and risk. ESGs provided a much broader and robust type of fund and their growth in the minds of both individual and intuitional investors is expected to continue.

Let’s look at the growing demand of ESGs in today’s markets. As ESG funds separate from the negative screening associated with SRI funds, there is a growing demand for ESG funds to be incorporated into investor portfolios. There are three main reasons that drive ESG funds forward in the fund universe.

  1. The perception of positive performance. Current investment sentiment is positive on the ability of ESGs to provide investment performance.
  2. Tying the ESG to investor values. Investors look to ESGs to deliver investment performance as well as aligning with positive results for their social concerns.
  3. Narrowing the information gap. Despite the perception of positive performance and funds that reflect their social values, there is a need for more information to support an ESG investment decision.
  • 60% of investor’s activity seeks out investments that align with their values.

56% of investors seek to avoid investing in companies that conflict with their values.

Now that we’ve looked at some aspects of the growing demand for ESG funds, let’s take a look at some of the strategies to arrive at an ESG fund’s objectives.

  • Negative Screening: Excludes countries, companies and industries based on poor ESG records and performance.
  • Best in Class Screening: Looks for sectors, companies, or projects that provide positive ESG performance compared to their peers.
  • Thematic strategies: Looks at megatrends related to global sustainability.
  • Impact strategies: Directed at solving social or environmental issues.
  • Engagement: Shareholder input to influence change on issues like climate change often through proxy voting policies.

It’s an interesting exercise to breakdown ESG preferences with individual investors. Investors worldwide agree on the importance of investing in companies that reflect their personal values.

On the environmental side, investors say their main concerns are pollution (52%), climate change (45%), waste and recycling (40%) and renewable energy (32%)*. In the social arena, investors were concerned with human rights (60%), employee health and safety (45%), economic inequities (38%), labor practices (29%) and gender equality (27%). In the realm of governance, the ranking concern was bribery and corruption (60%), transparency (48%) and business ethics (43%) were additional concerns. Executive compensation (23%) and shareholders rights came in at 23%.

Now that we’ve determined investors’ ESG preferences, let’s take a look at how investors monitor ESG exposure in their portfolios. Sin stocks (tobacco, weapons, gambling) draw the strongest reaction from investors. If we take a look at how investors would handle those stocks in their portfolios, 44% would sell, 18% would engage the company, and only 20% said they would continue to hold that particular stock.

Finally, we will look at generational differences in investing with ESGs. There is a definite split between the attitudes of younger and older investors. When looking at the same question, 56% of millennial investors believe their investments can have an impact, while 48% of Generation X, 41% of baby boomers, and only 30% of the Silent Generation hold the same belief.

The conclusion we can draw from these statistics is that ESG funds are growing in popularity, and they likely won’t stop anytime soon. In fact, 65% of institutional investors believe using ESG funds will be standard practice in the next five years.

*Source: Natixis Insight Series,Natixis Sustainable Future Funds”, https://www.im.natixis.com/us/natixis-sustainable-future-funds

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