ESG funds lose momentum as asset owners, managers rethink role
Institutional and retail investors are rethinking their investments in environment, social and governance (ESG) funds as they become more discerning about how they go about incorporating sustainability metrics into their investments.
Europe, the biggest market for sustainable funds, attracted $20 billion of net new money in the second quarter, compared with $33.7 billion in the previous quarter. Demand for sustainable funds has cooled over the past few quarters, indicating investor attitudes are evolving.
Since UCITS (undertakings for the collective investment of in transferable securities) funds domiciled in Europe form the majority of funds accessible to both Hong Kong and Singapore investors, trends within European sustainable funds are important to understand the bigger picture.
GROWING UP
“My observation would be that whether from a fund or company perspective, we are seeing some maturity starting to happen here,” said Joshua Crabb, head of Asia-Pacific equities at Robeco.
Investors were initially excited about getting involved in something seen as highly positive, but increasingly they are also seeing some negatives being associated with these funds, he said at a recent online conference on market outlook for the second half of the year.
“And I think investors are stepping back and saying, ‘this is a great idea, but how do we make sure we are doing this the right way?’”
Investors are more determined to ensure ESG investments provide the right outcomes, Crabb said. “I think the appetite is still there, but people are just becoming more sophisticated and moving more in the right direction.”
GREATER SCRUTINY
Even regionally domiciled fund flows were muted this year: Asia ex-Japan recorded net ESG fund inflows of about $172 million over the second quarter, according to funds flow tracker Morningstar.
Asia ex-Japan accounted for 7% of total sustainable fund flows in the second quarter, while assets totalled $67 billion over the same period, accounting for 2% of global assets, according to Morningstar.
David Smith, senior investment director of Asian equities at abrdn, noted that there is definitely greater scrutiny of ESG funds by investors.
“There’s a real focus now on ensuring that investment strategies and processes match the fund label. Providers of capital, both whole and institutional channels, are very focused on this due diligence,” he told AsianInvestor.
One of the markets where this phenomenon is increasingly visible is Australia, where the securities regulator has been clamping down on false and misleading ESG claims by both asset managers and Australian super funds.
ESG rules across the region, in fact, are getting stricter as regulators attempt to cut down on 'greenwashing'.
LONG-TERM POSITIVE?
Another short-term challenge is the strong peformance of 'non-ESG friendly' fossil fuel stocks in 2022, such as Occidental Petroleum and Hess Corp, both of which reported close to or more than 100% gains in stock price, on the back of the Ukraine-Russia war.
Many investors opted to increase short-term exposure to 'certain high emitting sectors' that were off-limits in the past, which was “a response to avoid short-term losses or underperformance,” said Laura Bosch Ferreté, sustainable investing specialist at Robeco.
The current geopolitical situation, nevertheless, has reinforced decarbonisation ambitions and investors are looking at improving energy security even as they try to decarbonise their portfolios over time, she said.
The relatively poor performance of ESG funds recently has also not helped.
Yet, short-term performance of such funds is unpredictable and can be dominated by sentiment and technical, Bryan Cheung, associate director of manager research at Morningstar, told AsianInvestor
“For instance, sustainable funds comprise mainly equity strategies which tend to have a growth tilt, and they generally struggled in 2022 when growth equities were sold off.
"In contrast, they generally did well between 2020 and 2021 when growth equities outperformed. Hence, there will be times where sustainable funds outperform or underperform the broader market,” Cheung said, adding that investors must hae realistic expectations of the risk-reward profile of different sustainable investing strategies.
The perception that ESG requires a trade-off with returns lingers with many asset owners, including Korea's Public Officials Benefit Association.
Despite these challenges, asset managers are keen to telegraph the message that the broader direction remains ESG-positive.That's the message asset managers are keen to telegraph -- that the broader direction remains ESG-positive.
“There’s a clear trend towards ESG funds among our clients, and the market more broadly, with strong interest in both ESG-integration funds as well as funds that aim to drive positive social and environmental change,” said abrdn’s Smith.
Funds claiming some kind of greenness passed the €5 trillion ($5.4 trillion) mark for the first time this year, according to Morningstar.
CONVENTIONAL V/S ESG
Another interesting trend is that the lines between conventional investments and sustainable investments are blurring as an increasing number of investors integrate ESG into their portfolios.
Thailand's Government Pension Fund, for instance, has said that it integrates ESG factors into the bulk of its portfolios.
Integrating ESG into the investing framework is a reflection of how investors are increasingly recognising the financial materiality of ESG factors, noted Ignace Nguyen, client portfolio manager for listed assets at Mirova, an affiliate of Natixis Investment Management.
“These factors matter because they have the potential to impact a company’s reputation, brand, sustainable growth opportunities, and ultimately financial performance and valuation."
Yet the convergence is probably happening only in a section of the market, said abrdn's Smith.
"ESG is a broad church and includes a range of approaches from screening to integration, to positive impact. We’re probably seeing more of a convergence in the ‘integration’ space, given how many funds are being launched or repositioned as sustainable.
"But I would caution against extrapolating that and concluding there’s a convergence between ‘conventional’ funds and ‘sustainable’ funds across the board,” he added.