The biggest changes in ESG investing over the last 10 years – part 1

The dizzying rise of ESG investing has arguably been the most striking feature of asset management over the last 10 years. According to Morningstar, ESG fund assets surpassed $1trillion in December 2019, and now stand at $2.2trillion globally at the end of June 2021. Having analysed funds in the space for the past decade, the scale of this growth is hard to overstate. But while the sector can now seem ubiquitous, it is worthwhile looking back at how – and why – we got here.

In the first of this two-part article, we cover the growth in choice and the rise of the ‘E’ and ‘G’ witnessed over the last 10 years.

Growth in choice – and true diversification

A decade ago, the ethical investment sector was one in which few UK analysts wanted to work. Partly, this was because ‘ethical’ was associated with lower returns. But it was also because the pickings were, at best, slim. There were only a handful of relevant UK equity funds – typically employing dark green negative screens, mostly avoiding the same ‘sin’ sectors like tobacco and alcohol – a smattering of global equity funds and some no-frills fixed income products.

Religion, morals and ethics were the dominant factors, with many funds linked to churches or religious movements. For example, contraception was a prominent feature of some fund screens because their investor bases were mostly Catholic. The ‘S’ was of greatest importance.

With the universe so narrow, portfolio diversification was virtually non-existent. To spread their exposures, some multi-asset funds simply held traditional open-ended property funds, none of which had explicit ESG characteristics.

Today, the landscape is radically different. In 2020 alone, more than 300 funds were launched in the sustainable fund universe – roughly equivalent to double the entire global sustainable universe in 2011.

This explosive growth has meant fund selectors now have far more choice than ever before. Vanilla property funds are long gone from sustainable and ESG portfolios: portfolio managers seeking exposure to alternatives can now choose from numerous close ended trusts with clear environmental or social impacts, such as SDCL Energy Efficiency Income Trust or The Renewables Infrastructure Group, and select from the growing number of absolute return ESG funds.

This is not just about one type of fund or approach. There are now hundreds of positive choices to encourage the transition to a more sustainable future for all.

Some areas still lack depth – we would like to see more established funds in the absolute return space, for example. But real – and positive – diversification is achievable now in a way it simply was not in 2011.

The rise of the ‘E’… and the ‘G’

Demand for funds with specific ESG mandates was steady if unspectacular before the Paris Agreement in 2015 to limit global warming to well below 2 °C above pre-industrial levels.

Whilst the environmental movement had been growing since Kyoto in 1992 and been in the spotlight at times with tragedies such as Deepwater Horizon, the historic agreements reached at Paris was the spark that ignited mainstream consumer activism about climate change. And that pressure, allied with the ‘Attenborough effect’ (with documentaries like Blue Planet magnifying the focus on environmental challenges like climate change, plastic pollution and deforestation), forced the asset management sector to respond to mounting demand for ESG and sustainable funds.

Today, many clients will, first and foremost, ask about our policies and screens with respect to climate change before even discussing return expectations. The ‘E’ has assumed pre-eminence, although the ‘S’ and the ‘G’, remain extremely important.

Engagement, once seen as something of a hobby for some, has become a critical issue. Fund managers are now expected to be responsible stewards of capital, using their voting power and voices at AGMs, EGMs and in boardrooms. Underlying savers want fund managers to use their platform and power to influence corporate behaviour and effect positive change.

In our view, active managers, despite the growing presence of passive funds on shareholder registers, remain best placed to do this. But either way, the fact that engagement has become so pivotal is another demonstration that ESG investing, once inextricably linked with exclusionary screens and avoidance, is now viewed as a positive force for change.

This article was originally published in full in Portfolio Adviser, October 2021. By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. The value of investments can go down as well as up and you may not get back the amount invested. Some ethical funds may, by definition, have a limited universe: this may affect performance. Issued by Tilney Investment Management Services Limited, authorised and regulated by the Financial Conduct Authority.