In the first quarter of 2020, many markets felt the first shocks of the COVID-19 pandemic on the global economy. However, inflows into Environmental, Social, and Governance (ESG) funds were resistant to the prevailing trend, and the sector saw robust levels of investment. How has ESG managed to outperform other sectors of the market?
- In the first quarter of 2020, ESG funds saw inflows of US$36bn, showing resilience in the face of widespread market volatility caused by COVID-19.
- The region that recorded the largest inflows was Europe excl. UK, with US$17bn. However, inflows into the U.S. and the UK tailed off somewhat on a quarter-on-quarter basis.
- During the period, the majority of ESG funds have outperformed their technical indicators.
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While the global economy has been struggling after the severe shock caused by the COVID-19 pandemic, there have been record ESG inflows. How has this sector weathered the storm more resiliently than others?
We should first look at how ESG flows in Q1 showed equal parts divergence and alignment with broader fund market flows. These flows most likely represent both the nascent nature of the ESG product space and the orientation of investors allocating into these funds.
Globally, total ESG flows registered around US$36bn, which was the lowest quarterly flow amount for over a year. All things considered, that isn’t too bad when you look at the events that took place in the markets in the first quarter.
Flows into ESG funds
The big winner for global ESG flows was equity products. They checked-in at just shy of US$20bn in new money.
This was about two-thirds of the approximately US$30bn flows into equity funds in the record-breaking prior quarter, and the second-highest quarterly equity flow number in the past decade.
Similar to the broader funds market, flows into equity funds continued on a fairly steady trend from prior quarters, registering quarterly flows that were close to record highs.
Investors in ESG funds tend to focus more on values than valuations, and they are accordingly less likely to be found pursuing market timing agendas and trading across asset classes.
Similar again to the broader fund space, ESG funds saw flows into money market products in Q1. However, this was off the back of Q4 2019, which saw very small outflows from these investor safety nets.
The behavior of ESG money market funds is somewhat erratic because they actually saw small outflows during the last market downdraft in Q4 2018, when one would expect money to pile in. They seem to be used more tactically for trading or parking, as opposed to strategically for asset allocation purposes.
Activity in bond funds, however, showed a divergence from prior trends and the broader markets as a whole.
Non-ESG products saw an exodus out of bond funds in Q1, particularly in the U.S., while ESG bond funds went from a fairly steady and robust trend of quarter-on-quarter inflows to near zero flows activity in Q1 this year. Nothing came in and, importantly, very little went out.
Regional ESG activity
From a regional perspective, inflows into ESG funds over the last 10 years have been dominated by certain regions.
In particular, investors have been solidly investing into EMEA excl. UK funds, followed by offshore funds (as defined by Lipper Methodology). UK and U.S. funds, which saw some of the largest interest from investors in 2019, has tailed off in 2020: UK 4Q19 $4.3bn vs 1Q20 $2.3bn; and U.S. 4Q20 $6.7bn vs $2.4bn
Global estimated fund flows chart (interactive) – below graph is a placeholder
Investors’ appetite for risk
Collectively, ESG investors showed a little more appetite for risk, and stuck to their long-term allocation strategies.
In the broader funds market, investors sold out of fixed income, held back on equities, and piled into money markets. ESG displayed a muted version of these three trends by going flat in fixed income, tempering inflows into equities, and revisiting money markets after a quarter of negligible flows.
When analyzing if ESG funds outperformed in the first quarter of 2020, it needs to be considered how difficult it is comparing such a small universe of funds with the broader funds markets.
Watch: Refinitiv Perspectives LIVE — ESG Investment, a cure all for asset management?
How did the oil market affect ESG investing?
A further consideration is the coinciding disruption in the oil market, which impacted all manner of carbon-intensive industries that many ESG funds tend to allocate away from.
In fact, the first part of the market sell-off in carbon-intensive industries was likely more tied to the oil market gyrations and less about COVID-19. However, the global pandemic impacts were felt more in the latter half of March and sealed the performance fate of these stocks.
In spite of that, the outperformance of global ESG funds versus the broader market was a little more than 1 percent on a net basis, with about 54 percent of ESG funds outpacing their conventional funds peers.
Chart: percentage of equity funds over-performing or underperforming (chart needs correct casing)
Considering the massive differences in the number of non-ESG funds and the breadth of product types, this is like comparing apples with oranges, but worth keeping an eye on.
A similar analysis of U.S. ESG funds showed even less significant results. Conventional funds had a much wider spread of returns and only trailed ESG themed funds by 10 basis points on a net performance basis.
We’ll revisit this comparison after another quarter or two to get a better picture and assess if there is a relationship worthy of note there.