ESG-focused funds and their growing share in global investment portfolios

Investing in ESG-focused funds outperforms investing in non-ESG-focused funds

ESG-focused funds and their growing share in global investment portfolios

Investors across the world are increasingly willing to place their investments into ESG-related companies and ESG-fund providers. In the fourth quarter of 2020, the total of globally managed ESG focused funds jumped by 29% to $1.7 trillion.

ESG investing is pursuing investments in companies that have a positive net impact on the environment, society, and practice better corporate governance. Companies with a strong ESG awareness and performance record help gain more trust among employees, suppliers, business partners, and investors. ESG investments focus on supporting companies that commit to long-term sustainability as part of their strategy, while also recognizing the risks of outcomes that could occur if ESG factors are not considered. While about a decade ago ESG investing was viewed as more of a goodwill initiative on the part of investors, it is now deemed as an inherent aspect of the company's sustainability and its long-term success.

In traditional stock analysis ESG-focused funds are often assessed for stocks based on value and growth in the same way as many other funds are; however, ESG-ratings providers also add other ESG-focused metrics for valuing ESG-focused funds, which may involve such criteria as fossil fuel exposure, ESG scores, disclosure practices, governance practices, workplace diversity, and others. Some studies have demonstrated that the cost of capital for companies with higher ESG scores tends to remain lower, on average, for four years compared to companies with lower ESG scores. This implies higher profits and higher returns for investors.

 Investors across the world are increasingly willing to place their investments into ESG-related companies and ESG-fund providers. In the fourth quarter of 2020, the total of globally managed ESG focused funds jumped by 29% to $1.7 trillion.

ESG investing is pursuing investments in companies that have a positive net impact on the environment, society, and practice better corporate governance. Companies with a strong ESG awareness and performance record help gain more trust among employees, suppliers, business partners, and investors. ESG investments focus on supporting companies that commit to long-term sustainability as part of their strategy, while also recognizing the risks of outcomes that could occur if ESG factors are not considered. While about a decade ago ESG investing was viewed as more of a goodwill initiative on the part of investors, it is now deemed as an inherent aspect of the company's sustainability and its long-term success.

In traditional stock analysis ESG-focused funds are often assessed for stocks based on value and growth in the same way as many other funds are; however, ESG-ratings providers also add other ESG-focused metrics for valuing ESG-focused funds, which may involve such criteria as fossil fuel exposure, ESG scores, disclosure practices, governance practices, workplace diversity, and others. Some studies have demonstrated that the cost of capital for companies with a higher ESG scores tends to remain lower, on average, for four years compared to companies with lower ESG scores. This implies higher profits and higher returns for investors.

According to S&P Global Market Intelligence research, more than half of the environmental, social, and governance-linked funds outperformed the S&P 500 from Dec. 31, 2020, to May 17. The outperforming ESG funds’ prices rose between 11% and 29.3% over that period. In comparison, the S&P 500 increased 10.8%.

Critics of ESG investing question whether the ESG-focused strategy can deliver premium returns. For example, Scientific Beta Group, which is linked to the French academic think tank Edhec-Risk Institute, claimed in its research that ESG ratings do not add value" beyond the kind of information already contained in sector classifications and factor attributes that are already used to attribute potential risk and performance in stocks.”

However, another analysis by professors at New York University's Stern Center for Sustainable Business and researchers at Rockefeller Asset Management contested that claim by Scientific Beta Group, suggesting that improved financial performance related to ESG becomes more noticeable over longer time horizons. The studies by these two groups found a positive relationship between ESG-focused metrics and corporate financial performance 58% of the time, while 21% had mixed results and 13% saw no impact.

Credibility with investors is likely to be a critical factor for an investment manager when allocating a greater share of growth in assets under management, and many investment fund experts believe ESG-focused funds are likely to increase further their share of the global investment market and drive a structural shift in the investment landscape.

Our asset management company Sigma Global Management utilizes ESG-focused funds along with other ones when applying our long-short strategy and even-driven strategy to building investment portfolios, and we have identified that applying ESG-focused funds to these strategies generates positive premium returns.

According to S&P Global Market Intelligence research, more than half of the environmental, social, and governance-linked funds outperformed the S&P 500 from Dec. 31, 2020, to May 17. The outperforming ESG funds’ prices rose between 11% and 29.3% over that period. In comparison, the S&P 500 increased 10.8%.

Critics of ESG investing question whether the ESG-focused strategy can deliver premium returns. For example, Scientific Beta Group, which is linked to the French academic think tank Edhec-Risk Institute, claimed in its research that ESG ratings do not add value" beyond the kind of information already contained in sector classifications and factor attributes that are already used to attribute potential risk and performance in stocks.”

However, another analysis by professors at New York University's Stern Center for Sustainable Business and researchers at Rockefeller Asset Management contested that claim by Scientific Beta Group, suggesting that improved financial performance related to ESG becomes more noticeable over longer time horizons. The studies by these two groups found a positive relationship between ESG-focused metrics and corporate financial performance 58% of the time, while 21% had mixed results and 13% saw no impact.

Credibility with investors is likely to be a critical factor for an investment manager when allocating a greater share of growth in assets under management, and many investment fund experts believe ESG-focused funds are likely to increase further their share of the global investment market and drive a structural shift in the investment landscape.

Our asset management company Sigma Global Management utilizes ESG-focused funds along with other ones when applying our long-short strategy and event-driven strategy to building investment portfolios, and we have identified that applying ESG-focused funds to these strategies generates positive premium returns.