By: Spencer Israel
You could argue that ESG investing (the Wall Street acronym for the investing theme that emphasizes Environmental, Social, and Governance standards) has been mainstream for several years now—and you’d have a point.
The term ESG was first coined all the way back in a December 2004 report published through a UN initiative. Building on the sustainable investing initiatives that had been around since the 1960’s, the report argued that companies should improve their environmental, social, and corporate governance practices not just because of the moral and ethical implications, but because it also makes good business sense.
(As a relevant aside, the acronyms ESG and SRI, short for Socially Responsible Investing, are often used interchangeably, but there’s a key difference. ESG is a return-focused investing strategy that focuses on how environmental, social, and governance factors can impact the bottom line and investor returns. SRI is a values-focused investing strategy that puts the emphasis on social values over everything else, including financial performance.)
And though this idea that businesses should be more socially responsible had been around for several decades, it was slow to catch on Wall Street. By 2014, 169 ESG-focused mutual funds and ETFs had been launched (that may sound like a lot, but there were over 10,000 mutual funds and ETFs in the U.S. that year).
That number has steadily risen in recent years, as has assets invested in those funds, however there have been many skeptics that ESG investing is a viable long-term investing strategy.
But based on two recent headlines, it sounds as if the masses may finally be coming around.
The first of those headlines is the apparent surge in popularity among ESG-focused funds last year. According to research from Morningstar, ESG-focused mutual funds and ETFs took in $20.6 billion in 2019—nearly four times the previous record of inflows set in 2018.
To put that in perspective, more money flowed into ESG-focused funds in 2019 than in the previous four years combined.
Overall, ESG-focused mutual funds and ETFs held $137 billion in assets at the end of the year. And though the size of these funds still only make up less than 1% of the $20 trillion mutual fund and ETF universe in the U.S., it’s hard to ignore such a strong year for growth.
As far as why the ESG theme was so popular among investors in 2019, there are likely a few reasons. Strong performance doesn’t hurt—in a year in which the S&P 500 rose by 31% on a total return basis, a Bloomberg analysis found that nine of the largest ESG mutual funds outperformed the index last year.
Part of the reason may also be the relative affordability of ESG funds compared to other investing themes. According to ETF.com, ESG ETFs had an average expense ratio of 0.38% in 2019. Though that’s twice as high as the average expense ratio for all U.S. ETFs, it’s far below the 0.63% expense ratio average for thematic ETFs as a whole.
A surge of money into ESG funds is part of what has us thinking about ESG investing. The other reason is Larry Fink.
‘A Fundamental Reshaping of Finance’
That was the headline of BlackRock CEO Larry Fink’s annual letter to the business community, in which he wrote how climate change is a serious investment risk and explained what his company would be doing to place a greater emphasis on combating the trend.
“The evidence on climate risk is compelling investors to reassess core assumptions about modern finance,” he wrote in the letter.
Fink announced that the company will make “sustainability integral to portfolio construction and risk management,” exit some investments with high sustainability-related risk, and pressure companies to abide by climate change standards.
“Given the groundwork we have already laid engaging on disclosure, and the growing investment risks surrounding sustainability, we will be increasingly disposed to vote against management and board directors when companies are not making sufficient progress on sustainability-related disclosures and the business practices and plans underlying them,” he concluded.
As far as influential opinions on Wall Street go, Larry Fink’s is near the top. As the head of the largest asset manager on Wall Street—BlackRock has around $7 trillion assets under management—his opinion carries weight. And his letter certainly caught people’s attention.
After a decade fighting for acceptance, it appears that ESG investing may have finally staked its claim in the limelight. The question is no longer whether ESG investing can grow at all, but by how much?
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