Global and UK ESG funds have underperformed over the past 12 months, according to new data, although new regulation is expected to continue to drive money into this sector.
Figures from AJ Bell show that over the past year the average global ESG fund (in the IA Global Funds sector) returned 6.6 per cent, compared to 8.7 per cent from a non-ESG fund.
In the UK the difference was even more stark with the average ESG fund (in the IA UK All Companies sector) returning 2.2 per cent compared to 5.9 per cent from its non-ESG equivalent.
The performance of ESG funds has been hit by rising oil and gas prices and increased profitability in this sector. Many ESG funds are underweight in fossil fuels.
However these same figures show that global ESG funds have outperformed non-ESG fund over three and five years. In the UK ESG funds have delivered marginally lower returns over these time periods, although the difference remains small at around 0.5 basis points.
While these figures relate to the retail funds market, similar trends are likely to be seen across the institutional fund sector.
AJ Bell head of investment analysts Laith Khalaf says: “The performance tide has turned against ESG funds of late, as growth stocks have floundered, and oil and gas companies have profited from rising energy prices.”
“That won’t stop money flowing into responsible investments though. There is genuine consumer demand for these products, and the investment industry has sunk a lot of marketing dollars into launching new funds and rebranding existing ones which now carry the ESG tag. On top of which, longer term performance of ESG funds compares favourably to more traditional offerings, especially in the global fund sector.”
He says regulation will drive further ESG flows. “We’re still in the foothills of ESG investing, and consequently the infrastructure to support investors is still being somewhat hastily erected.”
Khalaf points out that the FCA is consulting on introducing a green labelling regime in the next couple of months, which should add some much needed clarity to what investors can expect the extensive ESG vocabulary to mean in practice.
He adds: “Greater disclosure requirements could well drive further flows into responsible investment funds. Data compiled by Morningstar shows that 42 per cent of European fund assets now sit in ESG funds, even though the EU’s regulatory classification scheme was only introduced in March 2021. These funds are known as SFDR Article 8 and 9 funds.”
He adds that the widescale adoption of regulated ESG classifications in Europe suggests that the endgame is likely to see the majority of funds incorporating some kind of ethical framework into their investment process.
The AJ Bell data also looked at what the biggest individual holdings were within these ESG funds. The top 10 shares most widely help in global ESG funds include Microsoft, Alphabet (which owns Google), Apple, and Amazon. This tech giants are joined by a number of technology, financial services and healthcare companies.
Khalaf says: “Within global funds, the top ten most popular holdings have a distinctly technological flavour. That is perhaps unsurprising given the extent to which technology stocks feature in the world index at large, but also underlines these companies do tend to score well on ESG factors too. That’s despite the fact that some of them face questions around anti-competitive behaviour and the levels of tax paid in certain jurisdictions.”
He adds: “Looking at the most popular holdings in UK ESG funds, what is most notable is the number of financial services companies in the top 10.” This list includes Legal & General, Prudential, Lloyds and the London Stock Exchange.
Khalaf adds: “This sector tends to score well on ESG metrics, as it isn’t a heavy industry that needs to consume lots of carbon to conduct its daily activities. However, the inclusion of Lloyds might raise an eyebrow or two, seeing as the bank is still mopping up after past misdemeanours, and had to set aside £1.3 billion in the last financial year for customer remediation. Pharma stocks are also a bit of a shoo-in for UK ESG funds their core business results in better health outcomes for society at large.”