ESG in focus: What does the data say?

It was widely commented upon that 2020 was a watershed year for ESG – the societal impact of the COVID-19 pandemic, media attention on climate change and the Black Lives Matter movement all amplified interest in responsible investing.

When markets experienced significant turmoil in the early period of the pandemic, as economies went into lockdown, many were quick to highlight the relative outperformance of companies with higher ESG scores and specific ESG funds, as if a turning point had been reached. But the data for 2021 highlights a more nuanced and complex picture.

Energy beats ESG

Measuring ESG fund performance is not straightforward. This is because the term encompasses a wide array of investment options and ESG ratings differ markedly, depending on the provider.

But one trend was clear: the energy sector outperformed all others, as Figure 1 shows, bouncing back from being the worst performer in 2020. The MSCI World Energy index was up an eyewatering 42 per cent last year – 19 percentage points more than the MSCI World. 

Figure 1: MSCI World Energy versus MSCI World and MSCI ACWI (US$)

Past performance is not a reliable guide to future performance. For illustrative purposes only.
Source: MSCI World Index, January 2022¹

In contrast, the MSCI Global Environment index underperformed the MSCI World, (in large part) because of its underweight to the energy sector – though it still managed to return 16.7 per cent due to its high exposure to tech companies.

Indeed, this sector-bias has been one of the key drivers behind the recent outperformance of many ESG funds. In 2020, the MSCI Global Environment index skyrocketed 96.5 per cent, despite one of the biggest market sell-offs in history in March.

Figure 2: MSCI Global Environment versus MSCI World and MSCI ACWI (US$)

Past performance is not a reliable guide to future performance. For illustrative purposes only.
Source: MSCI, January 2022²

Don’t overlook D&I

The ethical case for diversity and inclusion is well understood. However, encouraging signs are also emerging on the business case. Figure 3 shows the Refinitiv D&I TR index outperforms both the MSCI World ESG Leaders index and the S&P Global 1200 ESG TR index over a ten year-period.

The D&I index ranks over 11,000 companies globally and identifies the top 100 publicly traded companies with the most diverse and inclusive workplaces, as measured by 24 separate metrics across four key pillars (diversity, inclusion, news and controversies, people development).³

Figure 3: Refinitiv D&I TR versus MSCI World ESG Leaders and S&P Global 1200 ESG TR (per cent)

Past performance is not a reliable guide to future performance. For illustrative purposes only.
Note: Rebased at August 2011. Source: Refinitiv, August 8, 2021⁴

The data reveals that cultural diversity metrics on company boards matter.⁵ Figure 4 compares two portfolios equally weighted over five years. They are created taking the Refinitiv ESG database as the initial universe – one with over 90 per cent board cultural diversity and the other with under ten per cent. The one with greater board diversity outperforms by a significant amount.

Figure 4: Portfolio with under ten per cent board cultural diversity versus over 90 per cent

For illustrative purposes only.
Source: Refinitiv, January 8, 2021⁶

Figure 5 used the same cut of data but with the FTSE All World index as a starting universe. The findings were similar – and the gap was even bigger.

Figure 5: FTSE All World board cultural diversity (per cent)

For illustrative purposes only.
Source: Refinitiv, January 8, 2021⁷

The unstoppable rise of sustainable bonds

Sustainable bonds totalled $1 trillion last year – a 45 per cent increase on 2020 and all-time record, as Figure 6 shows.⁸ Green bonds ($489 billion), social bonds ($193 billion) and sustainability bonds ($186 billion) all soared to new highs. Corporates accounted for 57 per cent of all issuance, and as Figure 7 illustrates, Europe dominates the market with over half of the deals by value.

Figure 6: Sustainable bond by issuer type ($bn)

For illustrative purposes only.
Source: Refinitiv, 2021⁹

Figure 7: Sustainable bond by region ($bn)

For illustrative purposes only.
Source: Refinitiv, 2021¹⁰

The expansion of the ESG universe

Unsurprisingly, allocations to ESG investment products have boomed in recent years and 2021 was no exception. According to Morningstar, global ESG assets grew to $2.74 trillion as of December 2021. Year-on-year, the global sustainable fund universe expanded by 53 per cent.¹¹

Figure 8 shows that, as with sustainable bonds, Europe continues to dominate the global sustainable funds landscape. Indeed, 81 per cent of sustainable fund assets were held in Europe, which remains by far the most developed and diverse ESG market, followed by the US, which accounted for 13 per cent of global sustainable fund assets.

Figure 8: Global sustainable fund assets (US$bn)

For illustrative purposes only.
Source: Morningstar, December 31, 2021¹²

The number of funds is also seeing significant expansion. Figure 9 shows product development over the last three quarters of 2021; an estimated 266 new sustainable funds were launched globally in Q4 alone, while 536 ‘conventional’ funds were repurposed into sustainable versions over the year, roughly double the number in 2020. This coincided with asset managers reacting to the European Union’s Sustainable Finance Disclosure Regulation (SFDR), which requires binding ESG criteria and exclusions to qualify for Article 8 and 9 status.

Article 8 funds include those that promote environmental or social characteristics but do not have them as the overarching objective, while Article 9 specifically have sustainable goals as their objective (for example, investing in companies whose goal it is to reduce carbon emissions).¹³

Figure 9: Global sustainable fund launches by quarter (number of funds)

For illustrative purposes only.
Source: Morningstar, December 31, 2021¹⁴

Regulations, ratings and flows

SFDR classifications are impacting fund flows – as are the various interpretations and assessments by data providers. Morningstar, for example, recently slashed its list of European sustainable funds by 1,600, or 27 per cent, with combined assets of $1.2 trillion.¹⁵

With great power comes great responsibility. Data providers play a crucial role by gathering and assessing ESG information and scoring companies and assets accordingly. It is instructive to look back at 2016 and Morningstar’s launch of its first sustainability ratings. Prior to this, investors had no easy way of judging the sustainability of funds, but the data provider introduced a five-globe rating system: where one globe indicates low sustainability and five globes high sustainability.

Figure 10 highlights the effect this has had on fund flows. Over the following 11 months, funds tagged as low sustainability saw net outflows of more than $12 billion, while those labelled as high sustainability saw net inflows of more than $24 billion. The ESG stakes are now higher; the question is whether the recent reduction in Morningstar’s sustainable funds list will have the same impact.

Figure 10: Fund flows before and after Morningstar introduced sustainability ranking (per cent)

For illustrative purposes only.
Source: European Corporate Governance Institute, April 2019¹⁶

Net-zero commitments: A start, but not enough

The Corporate Climate Responsibility Monitor¹⁷ produced by the New Climate Institute assesses the climate strategies of 25 major global companies and transparency and integrity of their climate pledges.

All of the 25 companies in this report pledge some form of zero-emissions, net-zero or carbon-neutrality target, but just three (Maersk, Vodafone and Deutsche Telekom) clearly commit to deep decarbonisation of over 90 per cent of their full value chain emissions by their respective target years.

Figure 11 shows no companies are seen to have high integrity, only one has reasonable integrity and three have moderate integrity. The inference is plain: words are not enough and need to be translated into action.

Figure 11: Integrity of net-zero pledges

For illustrative purposes only.
Source: Aviva Investors, 2022. Data from NewClimate Institute, February 202218

Furthermore, the targets for 2030 fall well short of the ambition required to align with the internationally agreed goals of the Paris Agreement and avoid the most damaging effects of climate change (see Figure 12).

Honey, I shrank the investible universe

Last but not least, for asset owners and managers with their own net-zero commitments, the portfolio construction challenges should not be downplayed.

According to a simulation by MSCI,¹⁹ the investible universe of companies aligned to the Paris target (of two degrees Centigrade of warming) will fall 60 per cent by 2030 unless material actions are taken to cut emissions. On the plus side, the threat of such a shift, not to mention investor and societal pressure, could push companies to decarbonise drastically.

Three points to remember:

• Measuring ESG fund performance is complex and subject to significant variations, depending on which sectors funds have exposure to
• Diversity and inclusion isn’t just the right thing to do for ethical reasons: the most diverse organisations tend to perform better too
• While many companies have committed to net-zero targets, few so far have put detailed plans in place to achieve this