We have had: the collapse of global markets in March, following the imposition of lockdowns across all of the world’s major economies; the instability during the final months of the Donald Trump presidency, and the subsequent delays to the stimulus package; and the impact of the Covid-19 vaccine roll-out, to name but a few.
One bright spot throughout the year, however, was the growth of ethical, sustainable and governance-focused investing, which took the industry by storm and captured investor imaginations worldwide.
With new regulations (the Sustainable Finance Disclosure Regulation) coming into force in March, we can expect to hear a lot more about ESG funds throughout 2021.
One of the major concerns about ESG investing is that investors have had to make sacrifices to their returns in order to have a more sustainable portfolio.
There have been arguments and counter-arguments surrounding this claim, but as ESG investing has grown, so too has a wider body of evidence emerged to challenge this maxim.
In late January this year, we published the first of our Crown Ratings (the second coming in July), which adds significant weight against it.
The Crown Ratings provide funds based across the globe with a rating of one to five, with five being the best performing.
The highest five-Crown rating is only given to the top 10 per cent of funds, based on three tests (alpha, volatility and consistency) over their entire history, with a three-year minimum qualifying period.
This year we found that ethical and sustainable funds have been among the best performers, with nearly a fifth of all the ethical and sustainable funds that were eligible achieving the highest possible five-Crown rating.
Across the sector, ethical and sustainable funds now account for 8.44 per cent of all five-Crown-rated funds, despite them making up just 5.04 per cent of the total 3,255 funds that were considered.
This is some achievement in a year where markets have been volatile and traditional assets have struggled.
At individual fund level, we can see from the chart below the performance in 2020 of two ethical/sustainable funds that gained the highest five-Crown rating at the first time of asking: Federated Hermes’ Impact Opportunities Equity and Fundsmith’s Sustainable Equity funds.
Both outperformed their Investment Association Global sector benchmark over the course of 2020, with Federated Hermes returning nearly 25 per cent in 12 months. While Fundsmith’s returns were not as high, they are still impressive, standing at 17.97 per cent in the same timeframe.
The funds’ investment aims give a clue as to their approach and the success behind it.
Apparent in their factsheets is the lack of any promises surrounding delivering returns in different markets, instead – in Federated Hermes’ case – to invest in companies that: “provide innovative solutions to societal needs, delivering positive social and environmental impact. This will be achieved by investing globally in a diversified portfolio of companies of any size.”
Here we can see that the objective affords the fund a certain degree of flexibility when it comes to diversification and investing in growth stocks in a range of markets.
The success of ethical and sustainable funds in the latest Crown Ratings rebalance comes largely at the expense of ‘non-sustainable’ asset classes.
Global lockdowns – and wider geopolitical events – saw the price of oil collapse in much of 2020, meaning that funds holding positions in energy companies have struggled. With global travel falling to a historic low, this problem has only been exacerbated.
Added to this, traditional equity investments have also had a tumultuous time. While US equities have largely boomed, thanks in no small part to high-growth technology stocks, other equity markets and particularly equity income funds have suffered as dividends have been curtailed.
Several funds unfortunately lost their five-Crown rating in this latest rebalance and, while certainly not the only one to have done so, Valu-Trac’s Equity Income fund is a good example of the knock-on effect of struggling equity markets on fund performance, as the chart below shows.
As we can see, the fund has lagged behind its IA Unclassified sector benchmark, losing more than 10 per cent of its value in the past 12 months.
For comparison, the chart also shows the performance of the sustainably-positioned Federated Hermes’ Impact Opportunities Equity fund.
At the time of writing, the impact of the Covid-19 pandemic continues to be felt and is likely to be felt well into the year ahead.
While the conditions for ethical and sustainable funds (growing interest, better classification, new regulations) are set to improve, for traditional stocks, the picture appears to be the same as before.
As the evidence becomes clearer that investors do not necessarily have to sacrifice returns for their principles, fund groups will increasingly direct their efforts and resources into making their investments more sustainable in the long term.
Charles Younes is research manager at FE Investments
