ESG performing well and in demand, but a shortage of ETFs is holding back adoption

Aug 19th, 2016 | By | Category: Equities

In a recent white paper, exchange-traded fund provider UBS found that ESG (environmental, social and governance) funds were just as good as conventional funds for the same risk.

ESG performing well and in demand, but shortage of ETFs is holding back adoption

Camilla Ritchie, Investment Manager, Seven Investment Management (7IM).

Also called ethical, sustainable or socially responsible, assets under management in ESG ETFs have risen nearly 45% to $3.4bn in the last 18 months, according to data from BlackRock, parent of iShares.

Data from index provider MSCI also corroborates this trend. Assets in ESG ETFs linked to its indexes grew by 50% to reach $2.1bn during 2015. Over the last two years, assets have grown by 140%.

And the trend looks like it will continue. Consultancy firm Mercer’s 2015 European Asset Allocation survey found that only 36% of institutional investors did not consider ESG risk factors when making investment decisions — the figure had dropped 12 percentage points from 48% the year before.

Fund performance is also speaking for itself.  Investment firm 7IM’s flagship Sustainable Balance Fund, which has nearly 20% of its fund invested in ETFs, has returned 5.1% over the last year, compared to the average fund, which has returned 4%, according to data from the Investment Association’s mixed investment category 20-60% shares (which is the sector the 7IM Sustainable Balance Fund falls into). It has assets under management of £65m.

The Investment Association compares 136 similar funds including sustainable and conventional funds, and it shows that the 7IM fund has outperformed the average fund by some significant margin over the last few years. Over three-years it returned 21.5% compared to 14.5%, and over five-years it returned 38.1% compared to the average 29.1%.

The fund is managed by Camilla Ritchie and while 18.4% is in ETFs, the rest is a mix of – futures, funds, and cash forwards. A portion of the assets – the strategic asset allocation – is outsourced and managed by investment manager Sarasin & Partners who pick sustainable equities and bonds.

While only 20% of the fund being made up from ETFs may seem small, especially for 7IM which is known for its use of ETFs, it may be because of the availability of ESG ETFs. For example, there is only one ESG ETF providing exposure to the UK – the UBS UK SRI ETF (LSE: UKSR).

Ritchie says: “There are not enough SRI/ESG ETFs for all the different asset classes. It’s all very well having a global equities SRI ETF but if it’s Emerging Markets equity exposure you are after that won’t help. In fixed income it would be good to see more offerings, such as in High Yield. There are corporate bond SRI/ESG ETFs but nothing in the lower credit rating/higher yield spectrum.”

Despite this, Ritchie makes use of those ESG ETFs that are available because of their benefits. “One of the benefits of ETFs is that I can increase exposure [to an asset class] with them if needed. So, for example, if the company policy is to increase the equity exposure, then I can do this easily with an ETF immediately.”

Like everything in the fund, the ETF must be compliant with ESG. In the case of an ETF it means that the underlying index must be compliant with the sustainable fund’s criteria. Ritchie says that while she performs her own due diligence she will only use ETFs on indexes she recognises and know.

“This is because to some extent I have to be able to rely on the index provider to have done their due diligence on the constituents included in the indexes we are invested in. However, ultimately because there is so little ETF choice we do pick the fund first – indexes we like are from MSCI and Dow Jones.”

One reason the fund been so successful is because in the last year the oil price has been very low and mining stocks have had a very difficult time. This has an impact on the fund because the allocation to energy and mining in sustainable funds is very low, they are stocks that are usually excluded, explains Ritchie. “In fact ‘miners’ are regularly excluded because they are often associated with bad working conditions,” she said.

It would follow that as the oil price rebounds performance will wane, however this has not been the case. Ritchie said: “Since the oil price has started to rebound the price we expected to see performance level out, but we are managing to hold position against the average.

“While this is one factor, we can’t ignore the stock picking, which has seen better than average performance and there has been a high weighting to long-dated bonds, which are the duration sector to be in.”

Costs

The fund invests in global equities and bonds, real estate, renewable infrastructure, social impact bond funds and alternative strategies.

The other notable factor is the uptick in money coming into the fund in recent months. Whether this is because of the performance, the awareness of responsible investing and/or the wave of younger investors, is still unclear.

However, Ritchie is keen to point out that investors are heavily influenced by the cost of the funds and will generally go for a fund that costs the least. She is keen to impress that the Annual Management Charge (AMC) is what the client pays, but the OCF (formerly the TER) is what they actually experience – and there is a difference.

The OCF (ongoing charges figure), which is the most accurate cost of the fund, is 1.4% p.a.. It is not the same as the TER, which doesn’t include trading, platform fees, etc.

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