Sustainable Investing  

Active management matches clients to the right ESG funds

This article is part of
Guide to sustainable investing

Active management matches clients to the right ESG funds

The coronavirus pandemic sent stock markets plummeting earlier this year, but many environmental, social and governance funds managed to weather the storm.

Throughout the crisis, companies that have strong sustainable credentials have tended to outperform those that do not.

ESG portfolios have fared better than conventional portfolios and are attracting record levels of cash as they have proved they can offer comparable returns.

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Figures from Morningstar show that sustainable funds recorded inflows of $71.1bn (£53.6bn) in the second quarter, sharply contrasting with the general equity outflows seen over the past year.

With the pandemic putting the focus on sustainable issues, it could lead to increased adoption of socially responsible investing and prove to be a major turning point for ESG.

However, the growing popularity of ESG has sparked fears of a post-Covid bubble, reminiscent of the technology boom in the 1990s.

Emma Foden-Pattinson, investment manager at Charles Stanley, says: “ESG bubbles could be formed as a result of investors seeking to invest in companies with high ESG ratings without taking into account other fundamental areas, such as valuations.

“As a result it can lead to some companies trading at very high valuations which might not be justified.”

Is there a risk of a bubble developing?

One of the key reasons that sustainable investing has seen a boom in recent months is because the crisis has shone a spotlight on the role good businesses play in society.

However, some experts say the outperformance is due to the fall in oil prices and a shift from riskier assets to more defensive sectors.

Record inflows into ESG funds are helping to drive up the value of companies with green credentials.

With the rush to invest more in a narrow set of assets, ESG funds could end up being overvalued.

While many experts agree that ESG stocks have pushed above what they are actually worth, it appears we are still some way off a bubble.

David MacDonald, founder of financial advisory business The Path, says: “Of course, some stocks have seen meteoric rises and the shares with superior ESG scores certainly trade at a premium, but as it stands this difference is only marginal.

“A good financial adviser, with a robust research process, can usually separate out the green from the greenwash – and ultimately determine whether it is a premium worth paying. So, I do not believe we are in bubble territory just yet.”

Chris Tanner, co-lead investment adviser to JLEN and partner at Foresight Group, points out: “Environmental criteria are increasingly written into regulation and must be complied. Therefore investing into funds with strong, genuine ESG credentials probably won’t result in a bubble. 

“However, if ESG funds are defined by a narrow ‘tick box’ criteria that allows for companies to greenwash their credentials, this may lead the market to downgrade the value of those with no real underlying ESG pedigree.”