The Rise of Socially Responsible Investing.

The last year has proven to be a very difficult period for investors as most asset types have faced a bit of a rollercoaster due to the Coronavirus pandemic that has swept the globe. One area of investment that has noticeably bucked the trend, however, is ESG funds.

For the uninitiated, ESG stands for Environment, Social, and Governance and refers to a set of criteria used to screen investment opportunities by socially conscious investors, although exactly HOW the criteria are defined and applied is a hotly debated topic. Regardless, ESG funds have historically been shunned by mainstream investors due to the perceived lower returns and higher levels of risk and volatility associated with them. Put simply, despite potentially agreeing with the socially responsible polices of the ESG funds and the underlying companies they held an interest in, individual investors were still seldom willing to sacrifice their bottom line.

So, what has changed?

In one word, technology. We live in the age of information, and the development of social media and the internet in general has led to retail investors and consumers being inundated with access to information that they have not had before. Activists have utilised these platforms to gain great support for a variety of ESG causes – and this has been reflected in investment markets – most recently a series of viral appeals from David Attenborough attempting to prevent further damage to the environment. This rising demand has been supported by companies worldwide offering sustainable solutions and socially responsible products to try to capture these emerging markets.

Previously inefficient, expensive technologies like solar panels and electric vehicles have seen huge advances in recent years and are becoming viable businesses. This has been reflected in recent times by solar panel and Electric Vehicle manufacturers leading the charge for the recent boom in ESG stocks and funds. The rising demand from investors is also bolstered by commitments from governments such as the EU’s green recovery plan or California’s recent commitment to removing fossil fuel powered cars by 2035.

The Coronavirus crisis has also shown that ESG stocks and funds have lost less and been less volatile in periods of market stress this year (traditionally not true of ESG funds). Some argue that better governance (the G in ESG) shows companies are better run and tend to be larger companies that can easily afford to strengthen ESG policies. When a crisis strikes, investors panic and tend to flock to safe assets. ‘A flight to quality’ is a term used to describe investors flocking to well run, large companies that have a strong likelihood of surviving. This could, in part, explain the recent successes of ESG based funds.

Another possible driver of performance in the recent crisis may be the selective exposure ESG funds take. Many environmentally conscious funds will have very little, if any, exposure to companies they think compromise the environment. As a result, these funds will have likely avoided airline and energy companies which have faced obvious (and large) struggles through the current pandemic. Although the pandemic has clearly accelerated these issues, there is a case to suggest this is the beginning of a more long-term trend. A perfect example can be seen by BP – a giant British company, known for its defensive attributes and strong dividend writing down its assets by £14billion in June – citing issues associated with the pandemic, as well as the move to a low carbon economy, which they feel is accelerating.

In any event, ESG funds have been consistently outperforming their counterparts in recent years, and a recent study predicted that ESG funds will account for over 50% of the European fund market by 2025 – over $5 trillion! This continued growth of consumer consciousness and investment flows into ESG funds, combined with advances in clean energy technology, and an inevitable need to revert away from our dependence on fossil fuels indicate there are still plenty of opportunities in the area. However, with the various areas of ESG investment and contrary definitions and styles it can be difficult to understand what you are investing in.