Over the past five years, there has been a dramatic increase in the awareness of Environmental, Social, and Governance (ESG) issues in investing. Consequently, many professional fund houses have touted the benefits of investing with an ‘ESG lens.’ This typically involves constructing portfolios comprising companies that score highly on various ESG metrics.
It also means excluding companies involved in activities that are considered anathema to ESG values or unsustainable. Many of these companies operate in industries such as oil & gas, tobacco, and gambling. A primary claim is that sustainable investing can lead to superior investment returns.
Indeed, according to Bloomberg Intelligence estimates, ESG-focused assets under management (AUM) will surpass $40 trillion by 2030, up from $30 trillion in 2022 as reported by the Global Sustainable Investment Alliance. But do ESG investment funds truly outperform their peers? Here’s what the data are telling investors.
Examining Long-term Outperformance
Before analysing the performance data, it is crucial to determine whether ESG-focused funds consistently outperform over the long term.
The data here are mixed.
For instance, according to the Morgan Stanley Institute for Sustainable Investing, sustainable funds achieved median returns of 12.6% in 2023, nearly 50% higher than the median returns of 8.6% for traditional funds. The institute’s analysis also revealed that an investment of $100 in a sustainable fund in 2018 would have grown by 35% by 2023, assuming median annual returns were achieved. This significantly outpaces the 25% median return for traditional funds over the same period. Throughout 2023, this outperformance by sustainable funds was apparent across stocks, bonds, and alternatives.
Source: Morgan Stanley Institute for Sustainable Investing analysis of Morningstar data. Data as of 9 February 2024.
Yet a large part of the outperformance in 2023 came from the overweighting of technology stocks that ESG or sustainable funds tend to hold.
ESG ETFs Fail To Provide Long-Term Outperformance
When investing in larger megatrends such as sustainability or ESG, exchange-traded funds (ETFs) are among the most popular vehicles used.
Scientific Beta, an index provider and consultancy linked to the Edhec-Risk Climate Impact Institute, analysed the performance data of all US equity ETFs classed as ESG or ‘socially responsible.’ These ETFs are domiciled in North America or Europe, and the analysis covered the period from 2012 to the end of 2022.
Scientific Beta found that the average annual return for ESG ETFs was 0.2 percentage points lower than for comparable non-ESG ETFs. Although ESG ETFs outperformed by a margin of 4.2 percentage points in 2020, this was an anomaly, and such outperformance was not consistently delivered over the long term.
Current evidence for meaningful outperformance in the mutual fund sector is similarly lacking. According to a study by The Journal of Finance, which examined 20,000 mutual funds with a collective $8 trillion in assets, funds rated highly for ESG factors did not outperform those rated poorly.
Comparing Similar ESG ETFs & Their Benchmarks
When comparing a typical large ESG ETF to its benchmark, a marginal underperformance becomes evident.
For instance, the iShares ESG Aware MSCI USA ETF aims to mirror the performance of the MSCI USA Index, albeit with a preference for companies with favourable ESG ratings.
As of the end of March 2024, the iShares ESG Aware MSCI USA ETF reported total annualised returns of 28.97%, 9.76%, and 14.74% over the past 1, 3, and 5 years, respectively. In contrast, the ETF’s benchmark, the MSCI USA Index, delivered total annualised returns of 30.26%, 10.80%, and 15.02% over the same periods.
As investors know, Big Tech stocks had a very strong 2023 overall performance. Likewise, in 2022—when Energy comfortably outperformed a broadly declining stock market—sustainable funds (which are underweight Energy) underperformed traditional funds.
Timeframe (Years)
iShares ESG Aware MSCI USA ETF Returns
MSCI USA Index Returns
1
28.97%
30.26%
3
9.76%
10.80%
5
14.74%
15.02%
While the MSCI USA Index’s outperformance is not substantial, it supports the findings from Scientific Beta’s analysis regarding the performance of ESG ETFs.
ESG Performance In Asia
While Europe and the US remain the largest ESG markets globally regarding assets under management (AUM), awareness of ESG in Asia is also on the rise.
In Hong Kong, data from the Hang Seng Indexes Company, which manages many of the benchmarks for the local stock exchange, indicates that its ESG indices have consistently outperformed their benchmark indices over the long term.
As of the end of 2023, the Hang Seng ESG 50 Index reported annualised excess returns of 1.72 percentage points over the benchmark Hang Seng Index, dating back to its base in September 2014.
Similarly, the Hang Seng Corporate Sustainability Index has delivered an annualised excess return of 1.89 percentage points over the Hang Seng Index since January 2008.
Investors are encouraged to delve deeper into the reasons behind the performance of ESG funds compared to traditional funds to determine if the observed outperformance or underperformance correlates or if it implies causation. This is crucial as ESG funds may possess specific characteristics, such as a higher concentration in technology companies, that could directly affect their overall performance.
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