Despite the hit from the pandemic, there is strong belief in the market that more and more financial instruments will gradually have an ESG connotation or wrapper, which is already the case with equities and bonds. This leaves us with funds, where a lot of literature is not available in terms of how to gauge funds considering ESG!
The net inflow into sustainable funds has seen unprecedented growth in recent times particularly since the onset of the corona pandemic. In 2021 the inflow breached the 500B USD mark for the first time ever and the overall net asset for sustainable funds stands close to 3T USD.
ESG funds are professionally managed with agreed investment process and strategies. Environmental, Social, and Governance factors are supposedly integrated in an ESG fund.
An ESG fund in a broader sense can mean it has one or more of the following characteristics:
- Broad ESG policy (i.e., minimum threshold on human rights) in order to establish a long-term, trust-based advisory relationship with their existing clients, despite any generational transfer of wealth.
- Thematic or norm screening (i.e., targeting certain sustainable activities which is aligned with the Paris agreement or SDGs) onboarding, suitability processes and client management, boost automation and remove paper, whilst never leaving the delivery of a first-class service to their clients aside.
- Negative impact exclusion policies
More than 250 new sustainable funds were launched in Q4, 2021. The market is also seeing increased activity in terms of repurposing existing funds into sustainable funds. Despite the rapid growth, currently in the global fund universe ESG funds only make up 5% of the total volume. Within the ESG funds the two main categories are ESG mutual funds and ESG ETF. Expectation is that ESG funds would continue to grow at a phenomenal rate in the current decade.
As an ESG fund can be a combination of various asset classes (primarily equities, funds, and bonds), the pertinent question then becomes how to measure ESG funds’ performance? Not surprisingly, the front runners of ESG rating markets, Morningstar (Sustainalytics), MSCI, Refinitiv, ISS etc. have jumped or are in the process of jumping onto this bandwagon i.e., ESG ratings/scores for funds.
ESG based funds usually face the following main challenges:
- Greenwashing risk
- Enhanced requirements from regulators
- Sub-optimal quality of ESG data
- Lack of engagement power or direct conversation with companies
- Fund managers are lacking a comprehensive understanding of detailed ESG issues
- Regulatory compliance considering SFDR, EU Taxonomy, PAI and other sustainable finance regulations on the horizon
The growth of ESG funds will continue for the foreseeable future, given unprecedented interest both from institutional as well as individual investors. ESG fund managers need to further build on their know-how in terms of how to integrate responsible investment in the governance and decision process. Fund managers should understand the limitations ESG ratings at fund level and need to be inventive in their approach.
Want to find out more? Register now to the webinar that will take place next 15 March at 2.00pm CET, Synechron and Objectway will deepen the topic and provide insights.
