Fund companies can follow a road map to ESG success

As investors and financial advisers fine-tune their focus on sustainable investing strategies, fund companies should tailor their offerings.


As investor demand for sustainable investment strategies continues to climb, fund companies are facing a more sophisticated and discerning audience, which could help separate the leaders from the rest of the pack.

New research from InvestmentNews sister company Last Word Media shows that ESG-strategy asset flows favor funds with the highest sustainability ratings.

Using Morningstar’s globe ratings as a guide, the research shows a predictable distribution of ratings, with the largest percentage of funds receiving average ratings, and globe ratings spread evenly across the high and low ends.

Data on 2020 asset flows, however, show that active equity ESG funds with the highest ratings suffered minimal outflows last year, while funds with average and below average ratings saw hundreds of billions’ worth of assets exit the strategies.

“If there was no correlation between sustainability ratings and fund flows, you would expect to see flows in or out roughly following the ratings distribution,” said Dylan Emery, director of research at Last Word Media. “However, what we’ve seen is far from that.”

The 12-month asset flow summary lines up with results from Emery’s survey of financial advisers, which shows consistent and specific commitments to ESG fund allocations going forward.

Asked how they anticipate their ESG allocations will change over the next 12 months, 68% of adviser respondents said they will increase or strongly increase allocations to funds aligned with the United Nations
Sustainable Development Goals.

ESG-themed funds will be specific targets for 60% of survey respondents, and active ESG solutions will see increased allocations by 57% of advisers.

Across eight categories of ESG investing, ESG-compliant core equity funds received the lowest anticipated increase, at 37% of respondents. No respondents said they plan to reduce ESG allocations in the year ahead.

In addition to pursuing strategies that align for ESG objectives, Emery’s research found that investors are also focused on the types of companies selling ESG funds and strategies.

Asked to rate the importance of various criteria at the fund group level, 21% of respondents said it is vital that the asset manager shows good corporate responsibility, while 54% ranked it as important.

A centralized ESG policy across all funds was ranked as vital by 28% of respondents and important by 36%, while a clearly stated definition of what ESG means to the fund company was ranked as vital by 37% of respondents and important by 27%.

In essence, investors are looking for the complete package when it comes to ESG products and not just a part-time effort.

The findings are in line with new research from EY Global Insurance and Cambridge Associates, both of which published reports Wednesday underscoring the growing appetite for ESG investing.

The EY report suggests consumer behaviors and priorities have dramatically changed as a result of the global pandemic.

More than half of the people surveyed by EY who were affected financially by the pandemic indicated that an insurance company’s stance on social responsibility issues like racial justice, environmentalism, income equality, police brutality and employee relations is very important in informing their decision to purchase insurance products.

The Cambridge research, which looked at the evolution of institutional practices around sustainable and impact investing, found a 146% increase since 2016 in the number of institutional investors who report making sustainable and impact-related investments.

More than 60% of respondents to the Cambridge survey are actively engaged in sustainable, impact or ESG investing, representing a 25-percentage-point increase from two years ago.

“Advisers are increasingly focused on working with managers that incorporate ESG criteria into their security selection process along with traditional fundamental and valuation metrics,” said Todd Rosenbluth, director of mutual fund and ETF research at CFRA. “They are also more likely to remain loyal even if performance suffers in the near term.”

In terms of what financial advisers and their clients are looking for in the ESG space, the Last Word Media research identified 10 investing categories that are lacking significant ESG representation: emerging market fixed income, Japanese equities, hedge strategies, commodity funds, private assets, U.S. equities, emerging market equities, property funds and developing markets fixed income.

Morningstar analyst Ben Johnson said that there are ESG gaps across the investing landscape and that some will be more difficult to fill than others.

“The areas of the market where advisers are looking for more ESG fund options are the ones where it is the hardest to build a viable ESG fund, owing to challenges relating to data availability, the breadth and depth of the opportunity set, and the nature of the asset class in question,” he said. “For example, it is going to be exceedingly difficult to build an ESG-intentional commodity fund.”