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ESG portfolios rely on funds with mid-ranked ratings

As Asset Allocator wanders the city speaking with DFMs and asset managers, it has become clear that ESG is expected to continue to be a growth area for allocators for many years to come.

With that in mind, and because enough time has elapsed since the boomiest bit of the boom phase, we thought we would look under the bonnet of the ESG portfolios we cover, to see if a trend has emerged. 

Our chart below shows the exposure of some of the different models we cover to funds ranked by ESG rating - specifically the Morningstar rating (other ratings are available, but we had to choose one). 

Despite its name, the Morningstar Sustainability Rating takes into account environmental, social and governance issues.

Perhaps unsurprisingly, there is a bit of crowding around the middle of the range, with allocators being overweight to funds in the middle to upper end of Morningstar's ESG fund ratings range. 

In most portfolios, the plurality of exposure is to funds rated four globes (Morningstar's ratings use globes rather than stars or crowns).

Something to ponder for allocators is the extent to which one can have a diversified ESG portfolio if overweight to a certain type of fund within an investment universe that is already arguably structurally exposed to certain sectors of the stock market and economy by virtue of the characteristics of the underlying companies that can invest in.

AJ Bell takes the most absolutist approach, as they have the largest exposure to five globe-rated ESG rated funds, while Abrdn has the lowest (the plurality of funds owned by Abrdn are rated three globes). 

Whether an ESG portfolio can be more sustainable than the component funds of which it is composed is something we will leave to readers to decide. Much like whether a broom with a new brush and a new handle is the same broom.

The most widely-owned two globe-rated ESG fund among the allocators we cover is Royal London Ethical Bond, which appears in seven portfolio ranges (and five of the ones in our graph).

For fairness (and, to be honest, curiosity) we asked Royal London about this and we were told the fund uses ethical criteria for exluding areas of investments and that it is not marketed as sustainable. We were also told the fund was launched in response to client demand for a corporate bond fund which excludes investments such as armaments, fossil fuel and gaming.

There were five other two globe-rated funds used by the DFMs in our graph, but these are not funds which present themselves as ESG, such as Abrdn Global Government Bond Tracker and M&G Emerging Markets Bond.

But Royal London Ethical Bond is not among the most widely-owned bond funds overall with the DFMs we cover. 

Three fixed income funds, each held in nine portfolios, top the charts. 

EdenTree Responsible and Sustainable Short Dated bond fund reached this tally following a very productive 2022 when it was bought by a net of three new allocators.  

Short dated bonds probably have a lot of appeal in a world of rapidly rising interest rates.

The other two bond funds held by nine allocators are Rathbone Ethical Bond, which had a net of one seller in 2022, and Threadneedle UK Social Bond, which survived the exit of its lead fund manager last year with no DFM exiting and one new buyer. 

Among the most widely-owned funds with five globes are Janus Henderson UK Responsible Income, Schroder Global Sustainable Value and Royal London Sustainable Leaders.

This last fund is one of the most widely-owned ESG funds of all - tied with Ninety One Global Environment - owned by 10 of the ESG allocators we cover. 

Ninety One Global Environment (which is rated four globes) also has a sizable and growing following among non-ESG portfolios.

A criticism of ESG investing is that most of the managers have yet to experience running money in this way in a recession or down market, 2023 will doubtless help sort the wheat from the chaff in that regard.

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