The Pandemic Finally Fixed ESG ETFs

Photo: Chris Liverani on Unsplash

While the COVID-19 pandemic has delivered a wide-scale disruption to global markets, it might have a lasting positive effect on sustainability. Recent data reveals that investors have been increasingly considering environmental, social, and governance (ESG) factors prior to making decisions about where to put their money.

Although ESG began to emerge as an important factor before the pandemic, the current crisis has permanently shifted both public and corporate attitudes on ESG and changed the face of responsible behavior.

This year, global markets suffered their worst quarter since the 2008 financial crisis. Growing demand for gold and the strong urge to find safe heavens underscored investors’ deep fears of being caught up in unprecedented volatility and global recession. At the same time, investors continued to pile into ESG exchange-traded funds (ETFs), revealing an unusual pattern in such strange times.

Green Trends

ESG-oriented ETFs represent only 0.8 percent of the $6 trillion of U.S.-listed equity ETFs, but they have accounted for over 30 percent of ETF inflows in 2020 thus far. According to The Wall Street Journal, investors spent more than $12.2 billion on ESG funds in the first four months of 2020, and this number is projected to grow throughout the year. A recent survey by Brown Brothers Harriman revealed that 54 percent of global investors plan to boost allocations into ESG ETFs in 2020.

One of the major reasons behind this shift lies in the fact that investors have become more concerned about the future of the environment – and the potential impact that ignoring environmental issues might have on their portfolios. For instance, in addition to public scrutiny, the list of potential repercussions for irresponsible investing could include lawsuits and hefty fines. Another reason is that ESG ETFs are safer and offer better returns than traditional assets in the currently volatile market environment. Recent data reveals that almost 80 percent of global ESG ETFs listed in Europe outperformed the companies of the MSCI World index this year.

Similarly, 76.9 percent of the U.S. and European ESG funds outperformed the S&P 500 and MSCI Europe index, respectively. This underscores the resilience of ESG funds, which generate better-than-average returns and offer a better hedge against market disruptions. In addition, The Wall Street Journal’s evaluation of ESG found that around 150 of about 200 funds surpassed the common return of a fund’s broader class. In effect, companies that implement material ESG principles are becoming associated with “high-quality” investments that are both resilient and demonstrate higher rates of returns.

The combination of concerns about environmental issues and ESG endurance contributes to shifting attitudes towards ESG ETFs. Sustainable investing has been around for many years and became popular long before the current pandemic, but it is only the ongoing disruption that might have facilitated its widespread recognition and effective integration into mainstream investing.

There are multiple industry transition trends that reflect growing ESG movements, including rising interest in alternative energy, efficient transportation, transition towards a circular economy, healthy lifestyle and reduced meat consumption, and demand for an equitable workplace and equitable social relations. The scope is set to further expand as responsible investing becomes part of the mainstream and begins to have direct impact on socio-economic factors.

Faster Transition

There are three major factors that facilitated the acceleration of flows into ESG ETF assets. The list includes the trend towards values-based investing as the breadth of investment options has reached critical mass, and the fact that investors have been able to observe the favorable performance of ESG ETFs through historic bear and bull markets during the last three years. The latter revealed the significant value of ESG ETFs in times of volatility that has been triggered by man-made impacts on the environment.

Investing into ETFs, however, has a few notable specifics. Because the funds are index-based, it could be troublesome to remove industries such as oil and gas and create products that are balanced and replicate the returns of specific geographic areas. In effect, the embrace of ESG ETFs still requires some degree of transition that would likewise deliver lasting changes to analytics and overall attitudes towards responsible investing.

Currently investors are looking at the stewardship practices of asset managers when choosing which products and companies to invest in. One of the most important aspects that has appeared as a result of the current outbreak is the interest in engaging with assets or firms that incorporate proxy voting, which provides an opportunity to foster positive environmental and social outcomes, including on the issues of climate change, pollution and transition to circular economy.

ESG ETFs have a clear comparative advantage during periods of market volatility, and allow investors to recognize the companies that demonstrate superior sustainability characteristics. The shift in investment preferences towards ESG ultimately shows that the pandemic may have managed to finally fix our attitudes to ESG ETFs – and draw attention to the economic benefits of responsible behavior.