By Carolyn Eagle, senior product manager, FTSE Russell and Jack Fischer, senior research analyst, Refinitiv Lipper
Interest in ESG at all time high
More institutional investors across the globe are considering ESG than ever before. A 2020 survey by FTSE Russell found that more than 7 in 10 asset owners globally are evaluating and implementing sustainable investment considerations in their investment strategies and among those using and/or evaluating smart beta strategies, 58% anticipate applying sustainable investment (SI) considerations to their smart beta strategy, up from 44% in 2019.
In North America, a region that has historically lagged other parts of the world on ESG investing, the share of asset owners that indicated interest in applying SI/ESG considerations to smart beta strategies jumped to 42% in 2020, from just 17% in 2019. Sustainable investment strategies continue to broaden, with a greater emphasis on more sophisticated approaches such as re-weighting based on SI and ESG factors (from 36% in 2019 to 55% in 2020) compared to more basic negative screening (64% in 2019 to 48% in 2020).
Are fund flows matching interest levels?
In short, yes. The growth in interest is translating to a growth in assets in the US. ESG/SRI AUM in the US is up to $550 billion, an 88% increase since 2018. With our colleagues at Refinitiv Lipper we asked the question What kinds of ESG strategies are attracting that AUM? Firstly, it’s important to understand definitions. Lipper’s ESG/ SRI universe of funds consists of funds that meet specific criteria to obtain one of the following flags: Social, Environment, Green, Ethical, and/or Religious.
Fund flow data from Lipper indicates that most of the sustainable fund flows are into passive equity strategies. In fact, according to Lipper, since the start of 2020, passive ESG/SRI funds saw ~70% of total inflows compared to active ESG/SRI funds (Chart 1) while only accounting for ~30% of total AUM in ESG/SRI funds (Chart 2). While active ESG equity estimated net flows are hovering around zero (meaning about as much AUM is flowing out as flowing in), ESG passive equity AUM estimate net flows are positive, and even ticking up in recent months.
Sustainable fund flows are mostly into equities
Of the $65.8 billion that flowed into passive ESG/SRI funds since January2020, $61.6 billion flowed into equity funds, while fixed income attracted about $4 billion in assets during that time.
Lastly, Lipper data indicates that while overall passive estimated net flows remains in positive territory, passive ESG AUM is steadily increasing month over month.
Globally, EMEA leads the pack, but North America is catching up
The same 2020 FTSE Russell survey finds North America is quickly catching up to EMEA when it comes to sustainable investment. In North America, 63% of asset owners surveyed said that they were either implementing or considering ESG, increasing from 39% in the last two years. That is still behind EMEA, where the figure is 85%, but regional differences are leveling off. This is especially true in the sub-strategy of smart sustainability—the combination of sustainability parameters and risk premia via factor exposure. The survey highlights that while 81% of EMEA asset owners expect to apply ESG criteria to smart beta (up from 73%), North America has jumped to 42% anticipating the same, which is up significantly from only 17% in 2019. These figures are a strong indication that interest in sustainable investing and smart sustainability has not only weathered the market uncertainty of 2020 but maintained a mainstream position despite disruptions like the global pandemic and heightened volatility.
Fund flows and performance
In recent years, it’s become more accepted across the industry that there is correlation between ESG performance and listed equity risk-adjusted returns, due in part to the correlations between better management of ESG issues and risks and corporate financial performance, cost of capital, market valuations and volatility. While it is important not to confuse correlation for causation, we do find in practice some evidence of risk-adjusted outperformance of ESG indexes against their parent benchmarks. Over the period from December 2016 through August 2021, the Russell 1000 ESG Enhanced Target Exposure Index outperformed the underlying benchmark’s annualized gain of 18.68% by 97 basis points, with comparable volatility. The tracking error over this period remained under 1% at 0.92%. Over the same time period, the Russell 1000 ESG Screened Target Exposure Index had an annualized return of 19.63% compared to the Russell 1000 index return of 18.68%. Further, an alternatively weighted index methodology, in this case Target Exposure, produces indexes that behave very similarly to their underlying benchmark and therefore can be seen as suitable replacements for the traditional benchmark, further driving assets into the strategies. Likewise, it can also serve as a gateway or steppingstone for the newest ESG investor.
In closing, we see the demand for sustainable investing – combined with benchmark-like risk and returns and even some outperformance – leading to new index developments, sustained inflows into passive ESG/SRI funds, and the mainstreaming of ESG into passive.
 Smart Sustainability: 2020 global survey findings from asset owners, FTSE Russell.
 Smart Sustainability: 2020 global survey findings from asset owners, FTSE Russell.
 Source: Refinitiv Lipper. Includes both active and previously liquidated funds (ETFs and mutual funds).
 Social: A flag that identifies funds that use social criteria as part of their investment policy.
Environment: identifies funds that include environmental impact in their overall process.
Green: identifies funds whose main screening criteria/investment strategy is based primarily on environmentally friendly investments.
Ethical: indicates if the fund only invests in securities identified as ethical according to its mandate and avoids investing in stocks identified as unethical.
Religious: identifies funds that have adopted investment policies and/or screens their investments based on specific religious values or beliefs.
 PRI: ESG factors and equity returns – a review of recent industry research, 2021.
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