According to a recent report by Morningstar, an investment analysis firm, sustainable funds collected US$51.1 billion in net inflows in 2020, which was more than double 2019 net inflows. Sustainable inflows accounted for a quarter of all invested funds in 2020. The news comes three months after Morningstar formally integrated ESG into its analysis of stocks, funds, and asset managers.
Sustainable fund holdings vary, but assets tend to have lower ESG risk, are dedicated to reducing emissions, promote social wellbeing and community involvement, and vote in favor of environmental initiatives, sometimes even at the expense of short-term profitability. ESG investments were criticized in their infancy under the notion that corporations should be devoted to profitability and ignore ancillary motives. But ESG funds have gained traction, and especially since 2015, have proved that a focus on stakeholder success, not just shareholder success, is a better long-term philosophy.
Folks from retirees to college graduates are flocking to ESG funds. The surge in interested parties has resulted in dozens of new ESG funds. Seventy-one sustainable funds were launched in 2020, higher than the record 44 funds that set up shop in 2017. As of the end of 2020, there are now just shy of 400 sustainable funds in the US, over 75% of which launched in the past five years.
Types Of Funds
About 30% of these funds are exchange traded funds (ETFs) and 70% are open-end funds. ETFs are essentially an index, like the Dow Jones Industrial Average or the S&P 500, that is meant to reflect the upside and downside of a certain asset class. There are plenty of solar and wind ETFs, but also more niche ETFs focused on hydrogen or electric vehicles. There are even ETFs that focus on just one sector, such as technology or consumer discretionary, then select the most ESG-conscious companies and bundle them into an index. Open-end funds are similar to ETFs, but instead of simply buying a certain number of securities and holding them for years (as ETFs often do), open-end funds vary their investment approach and change their holdings more drastically based on prospective companies (see “An Introduction To ESG,” First Quarter 2021 ESG Review, p. 2).
Whether it’s an ETF or an open-end fund, the majority of ESG investment vehicles offer little to no fees, are easily open to the public, and focus on a passive investment strategy (open-end funds don’t have to do this but generally do). Interestingly enough, this simple approach has beaten the broader stock market, as well as more actively managed mutual funds and hedge funds, for the past few years (including 2020). During the height of the COVID-19 pandemic, more money entered ESG funds than exited them, despite widespread panic and one of the worst stock market crashes since the Financial Crisis. However, 40% of all ESG fund net inflows occurred in the fourth quarter of 2020 as the economy began rebounding and the stock market reached a new all-time high.
Although around 70% of ESG funds are equity funds, there are other categories available as well. In fact, around 20% of ESG funds are fixed-income funds, which give investors a set return similar to a savings account or a dividend. The remaining 10% or so of funds are allocation funds. Of the 269 equity funds, around half are in US stocks. Given the international scope of ESG investing, and that much of the progress is occurring outside the Unite States, over 25% of all ESG funds are in international equity funds.
New Kid On The Block
It’s hard to ignore just how relevant ESG investing is becoming. Aside from meteoric growth, ESG investments continue to comprise a larger share of total investment assets, and in 2020, generated interest even as the economy was collapsing. In 2012, US ESG-mandated funds totaled US$3.7 trillion, comprising just 11% of professional managed assets. By 2018, it was 26%. Deloitte Insights estimates ESG-minded assets are hitting their big growth spurt right now and could reach US$34.5 trillion, or 50% of US professional managed assets, by 2025.