The Covid-19 pandemic has been an active catalyst in bringing to light the inequality prevalent within society and the strenuous ramifications that a large portion of our society is subjected to as a result. This has caused the individual to re-shape their thinking not only on social/community issues but also on issues relating to the forward-looking changes that impact the economy. In the past these issues might not have been an urgent reality, however this pandemic has certainly left us all with a refined paradigm which accepts that the simple luxuries which we enjoy could easily be taken away if we are not cautious moving forward. This has contributed to the growing trend of investors becoming more “sustainability” conscience resulting in their portfolios becoming more considerate of ESG factors.
ESG funds, specifically in the US market, have benefitted from this theme – seeing inflows of over $22 billion which is approximately three times higher than the total inflows into similar ETFs in 2019. This extreme shift to ESG investing is even more prominent when considering the inflows into similar sustainability ETFs in European markets during the first quarter of 2021, which overtook the inflows of all other ETFs during the same period. In Europe, assets in passive funds tracking ESG based indices grew from $59 billion to $174 billion last year. An important factor to also take into account when considering the nature of future inflows into ESG focussed financial products, is the millennial investor. Ernst & Young has found that a large part of the demand for sustainable investments is being driven by “the millennials who prefer to invest in alignment with personal values”. Considering the fact that in 2021 we see the first group of millennials reaching the 40-year-old mark, we should begin to observe wealth being transferred from the baby boomer generation to the millennial, with the millennials expected to inherit approximately $30 trillion over the next few decades as reported by MSCI.
With this we are very likely to see more ESG financial products/services available to the investor. The only problem, however, is that due to the current lack of regulation surrounding ESG instruments, and taking into account the subjective nature of ESG scoring, investors are at risk of investing in what may seem like an ESG centred investment only to find that this may not be the case when looking at the detailed sustainability data. For instance, in 2020 BlackRock Inc.’s iShares ESG Aware MSCI USA ETF holdings included Exxon Mobil Corp and Chevron Corp while its biggest holdings were in tech companies under investigation for monopoly abuse. These kinds of occurrences cause one to question the legitimacy of many of the ESG products currently available to an investor. As previously mentioned, this matter is caused by the subjectivity of the ESG rating exercise. The MIT Sloan School of Management performed research on the reliability of ESG data provided by prominent ESG rating agencies and found that the average correlation between the ESG ratings provided by the various agencies was 0.61. For context, the same research was done looking at the correlations of the credit ratings from Moody’s and Standard & Poor, and this correlation was sitting at 0.92 (being highly correlated in comparison to the ESG rating agencies showing a much lower correlation).
In March 2021, the EU took an unprecedented stance in enforcing rules to regulate the sustainable finance industry. With this regulation being rolled out, fund managers that claim to invest in line with ESG considerations will now have to publish a tangible and measurable plan of how the process will be performed and the continuous disclosure changes applied to meet industry best practice. These rules known as the Sustainable Finance Disclosure Regulation (SFDR) dictate that all financial firms that have investors in the EU will have to put out a detailed disclosure pertaining to the ESG factors considered during portfolio construction and the ESG implications of current holdings.
In South Africa, we can see the ESG theme also starting to take shape. Last month Old Mutual released the first platform in South Africa to publish ESG ratings for local unit trusts (both internal and external to the Old Mutual stable). For now, they are still in the early stages, with their ESG rating methodology based solely upon that of the MSCI data. However, as time passes, we do foresee other South African institutions introducing the same type of service to market. This should lead to local funds’ ESG ratings becoming more meaningful over time. It is for these reasons that we find it important for the South African asset manager to be ESG conscience if they are to remain competitive in this new environment where ESG has become a more meaningful consideration to investors.