Assessing The ESG Investor

November 09, 2021

In the United States, ESG has gone from a fringe idea to one that has generated increasing interest from investors and issuers alike. Nearly 40 socially responsible ETFs have launched so far this year, and a total of $114.6 billion in AUM are held within these types of strategies.

As the space evolves, understanding investors’ motivations for these types of investments can be critical for figuring out the path forward. Two recent surveys from Federated Hermes and FTSE Russell help shine a light on what is driving assets into ESG and how U.S. investors’ motivations are different from investors around the world.

 

Social Issues Take Priority

ESG ETFs that are focused on the environment and climate change are among the most popular, with funds like the iShares Global Clean Energy ETF (ICLN) and the Invesco Solar ETF (TAN) being some of the largest funds in the space.

However, investors in both surveys identified social issues as being of high importance to them at this moment. These issues were put in the spotlight last year, highlighted by the pandemic and racial justice movement in 2020.

With that context, it is no surprise that 60% of respondents in the FTSE Russell survey said social themes were of priority focus. U.S. respondents showed preference for these themes over climate and carbon-related sustainability issues. Diversity, equity and inclusion were also high priority for respondents to the Federated Hermes survey, and had increased in importance since the year prior.

While popular broad ESG funds like the iShares ESG Aware MSCI USA ETF (ESGU) take these factors into account, ETFs that are targeted toward these issues such as the Impact Shares NAACP Minority Empowerment ETF (NACP) have not seen the same investor adoption.

 

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Chart courtesy of FactSet

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One reason for investor reliance on broad ESG integration ETFs could be that thematic ETFs are considerably more expensive. They also have higher tracking error to the benchmark, which could be a concern for some investors.

Mary Green, client portfolio manager for ESG at Federated Hermes, thinks that the focus on integration is the first step: “ESG integration is going to become fundamental investing. We’re not going to be talking about ESG integration in 10 years; it’s going to be an accepted value-added part of the investment process.”

“Younger investors are more interested in investing with purpose in a thematic way,” she added. “I think those are going to be the investment strategies for tomorrow.”

Importance Of Performance

A common perception of socially responsible investing is that it has a negative effect on performance. Some have even speculated that investors might be willing to sacrifice financial performance in exchange for aligning their investments with certain values.

However, this does not appear to be backed up by the research from FTSE Russell’s study. Fewer than 10% of survey respondents were willing to trade financial return for social or environmental impact. And half of the respondents felt sustainable investment practices were correlated with better portfolio returns over time.

The Federated Hermes survey had similar findings. More than half of the investors surveyed believe that better ESG practices result in stronger returns over time. The asset manager noted that this is an increase relative to other institutional ESG surveys, suggesting this is a perception that is changing.

The investors surveyed seem to agree that companies who ignore the movement toward answering to ESG standards in the boardroom are putting their investors at risk. And research has shown that sustainable investing can even be additive to long-term performance over time, supporting the responses given by survey respondents.

Though track records are limited for most socially responsible ETFs, ESGU has outperformed the SPDR S&P 500 ETF Trust (SPY) by a cumulative 6.6% since its December 2016 launch.

 

 

Lack Of Clarity Gives Investors Pause

Two themes that showed up across both surveys was investor hesitation around the lack of a clear definition for ESG and lack of availability of robust data. More than half of the institutional respondents in the Federated Hermes survey cited both of these factors as a barrier to greater ESG adoption.

Respondents in the FTSE Russell survey also expressed a desire for more reliable and widely available data. As mentioned above, many of the survey respondents signaled a focus on social causes. Of those who didn’t consider social themes to be a current priority, more than half said they would prioritize these causes if social data were widely available.

Respondents also expressed a desire for reporting and standardization when it comes to ESG and climate reporting. While the desire for regulation is weaker in North America relative to the rest of the world, 61% of all respondents felt that the development of corporate ESG and climate reporting requirements would be helpful for investors.

The results of these surveys suggest that regulation around standardized definitions and disclosures would give investors increased confidence in ESG investing. This process has already begun in Europe, and the SEC is examining ways to standardize ESG reporting in the U.S.

With considerable overlap in the survey results from Federated Hermes and FTSE Russell, the themes that emerge from the data paint a picture of what is driving investor decisions in this growing space and the necessary steps to increase adoption in socially responsible strategies.

Contact Jessica Ferringer at [email protected] or follow her on Twitter

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