Are swathes of ESG fund launches creating the next dotcom bubble?

Just this week ASI, JPMAM and MSIM have announced sustainable fund launches

There has been a flood of launches over the past two months on sustainability and climate-related areas.

On 14 December alone, three large asset managers unveiled sustainable strategies. Aberdeen Standard Investments and JP Morgan Asset Management launched sustainable emerging market equity funds, while Morgan Stanley Investment Management launched a UK sustainable fixed income strategy.

This adds to climate-related products from Robeco, Amundi, LGIM, plus specialists such as iClima Earth, all launched this quarter.

According to Morningstar data, the total number of funds in the European sustainable fund universe stands at 2,898 and 3,774 on a global basis, as of end of September. Overall, global assets in these strategies hit $1.25trn in Q3 this year.

Historically, this has been a cause for concern, suggesting a sector is heating up. Is there a bubble in the making?

See also: – ESG Clarity‘s latest digital magazine November 2020

Dotcom deja vu?

The recent launches have been largely focused on climate and energy transition.

The L&G Clean Energy Ucits is designed to invest in companies that are at the forefront of the United Nations Sustainable Development Goal 7; whereas the JP Morgan Carbon Transition Global Equity Ucits ETF will track the proprietary JP Morgan Asset Management Carbon Transition Global Equity Index.

Meanwhile, Robeco has launched two fixed income strategies focused on climate – the Luxembourg-domiciled RobecoSAM Climate Global Credits and RobecoSAM Climate Global Bonds.

Earlier in the year, there were Paris Agreement-aligned ETF launches from Amundi and Lyxor.

Anyone who remembers the proliferation of technology funds launched during the height of the 1990s technology boom may be looking at these launches with some trepidation, remembering the slew of dotcom launches that characterised the last bubble.

See also: – ‘Unprecedented’ number of new funds drives European sustainable AUM to fresh high

But there are different factors at work in these climate-related funds today.

Drivers for sustainable investing are long term

Certainly, there is a lot of demand for this type of product, but it has different drivers to the ‘fast buck’ mentality driving much of the technology bubble.

The Covid-19 crisis has galvanised demand as it has become clear that lots of countries want strong action on climate change and a green recovery from the pandemic.

See also: – Is a bubble forming in ESG investing?

As such, many green businesses have solid underpinning.

Some of this demand is driven by performance – ESG-aligned assets outperformed the market during and after the Covid-19 sell-off.

However, this is more likely to be a recognition that it is possible to invest sustainably and not lose money. The extent of the outperformance isn’t so high it would be the lure for investors.

Mostly demand is coming from a long-term shift towards sustainable assets.

Lagging passives

A recent PWC report shows that the vast majority of institutional investors expect a convergence between ESG and non-ESG-products by 2022.

More importantly, it shows 77% of them plan to stop buying non-ESG products in the same year.

The report added: “In Europe alone, in our best-case scenario, we expect ESG fund assets under management to account for over 50% of total European mutual fund assets by 2025. This will represent a staggering 28.8 compound annual growth rate from 2019 to 2025.”

In this scenario, these new launches are simply reflective of an industry where products are catching up with demand, rather than a bubble scenario.

Against this backdrop, passive funds had significantly lagged.

Earlier this year a study from Create Research found that 56% of pension schemes still do not own climate-related passive funds.

The report, which looked at 131 pension plans from 20 countries with combined assets of €2.3trn, found a quarter had a significant allocation (15% or more) to climate-related strategies in their passive portfolio.

Simone Gallo, managing director at ESG consultancy MainStreet Partners, says that part of the swathe of recent launches represents frantic catch-up efforts on the part of passive funds.

The necessity for this catch-up, he adds, has been given new impetus by the imminent Sustainable Finance Disclosure Regulation.

This requires asset managers to disclose the impact of their products, the steps they are taking to minimise the adverse impacts and their engagement policies.

Proper comparison

These new launches have been made easier by wider availability of benchmarks on which to base a passive strategy.

S&P Dow Jones Indices has launched a range of Paris-Aligned Climate Indices, while MSCI’s Climate Change Paris-Aligned indices are based upon the parent MSCI Europe and MSCI World indices.

These indices reweight or exclude securities, based on their exposure to the transition to a low carbon economy.

For example, the MSCI indices aim to maximise exposure to companies with carbon reduction targets, while being underweight companies that score high for use of fossil fuel.

The composition of these indices has, in turn, become easier because of better disclosure and wider availability of data.

Gallo adds: “A lot of the recent launches have been connected to the CO2 Paris Agreement. This creates greater availability of data and means products can be built more readily around the theme.”

He also points to the EU Taxonomy, due to come into force in 2021, which will bring in more transparency around climate change: “By default, we will see an increase in sustainable disclosure and an increased ability to build products. This gives a level playing field and allows proper comparison.”

This overcame a major hurdle. A lack of robust, independent data had created a significant barrier for the creation of passive climate change indices.

Companies tended to report their own carbon footprint and there were concerns over ‘greenwashing’.

Remnants of the bubble

Certainly, there are echoes of previous bubbles in the speed and enthusiasm with which new products have come to market in the climate change sector.

But there are sound structural reasons why this is happening.

Equally, it is worth noting that while the technology bubble burst with some force, the technology trend still proved to be extremely important and exciting.

Climate change may prove to be far bigger.

This article initially appeared in ESG Clarity‘s sister title Portfolio Adviser

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Natalie Kenway

Natalie is global head of ESG insight for ESG Clarity and has been an investment journalist for 16 years. She won Editor of the Year at the Aviva Investors Sustainability Media Awards 2021, and was Winner...