ESG ‘will soon be the norm’

ESG funds and ETFs are seeing outflows after three years of inflows – are investors falling out of love with ESG?

We have indeed witnessed the sharpest quarterly slowdown in sustainable fund net inflows over the past three years: this is due to several factors. We have seen a broad-based market correction in the past few months across regions and sectors, with value stocks strongly outperforming their growth sector peers since late 2020. One must remember that ESG stocks typically have more of a growth bias.

Macroeconomic headwinds such as inflation, rising interest rates and market volatility have also had an impact. That said, ESG fund inflows and new fund launches remained resilient in the first quarter of 2022.

According to Morningstar, global net inflows into sustainable mutual funds and ETFs in the first quarter of 2022 totalled just less than $100bn (with more than 80% coming from Europe), down from $150bn the previous quarter.

In fact, inflows into sustainable funds during Q1 2022 significantly outperformed those in the overall global fund universe, which plunged by more than 70% quarter-on-quarter. It is worth pointing out that at the private banking level, we have seen a significant rise in the compound annual growth rate of assets under management deployed in sustainable investing, which reached as much as 60% for some private banks over the past three years, globally.

This is a secular trend which will, at times, be impacted by volatility and market pull-backs, but the direction of travel for ESG remains very clear: we are witnessing a paradigm shift and sustainability is clearly here to stay.

We’ve had a number of ESG-related scandals this year – how do we repair investors’ faith in sustainable investing?

There is certainly greater awareness around some of the pitfalls and potential risks linked to sustainable investing, which have been brought up by the recent ‘greenwashing’ events. However, we still believe that investors’ growing appetite and interest for sustainable and impact investments remain intact.

Regulatory initiatives have accelerated over recent years – along with greater scrutiny of ‘green’ claims, both inside and outside the European Union. The aim is to protect investors and to maintain trust in the market by ensuring that capital is allocated in ways that will help meet net-zero targets as well as other sustainable commitments.

It is important to stress that sustainability is a journey. While some clients are quite sophisticated and have been investing in this space for a while, most investors – especially in this part of the world – are just getting started, becoming more familiar with what is at stake and how to integrate sustainability or impact investing in their overall asset allocation and investment portfolio.

In general, we are already seeing changes. In recent years this includes the realisation that integrating ESG into a portfolio goes beyond risk mitigation and value preservation (which we saw during the first few months of the pandemic); that ESG is also very much about value creation.

Corporates are seeing the benefits of integrating ESG into their businesses. In fact, there are many [investment] opportunities attached to the energy transition and sustainability transformation. The World Economic Forum estimates that environmental-focused solutions could generate $10.1tn of annual business opportunities and create 395 million jobs by 2030.

Taking a step back, environmental, social and governance considerations will be more and more at the heart of the way any business is run. At the end of the day, ESG is for business purposes. It’s about doing better business in the sense of more sustainable and more resilient businesses that are better for consumers, employees, shareholders and stakeholders – including, but not limited to, investors.

Which of the E, S or G are your clients favouring as an investment strategy?

It is difficult to generalise as it really depends where investors are on their sustainability path. The more ‘advanced’ clients might wish to further complement their existing asset allocation and further invest into ‘impact’ solutions.

At BNP Paribas Wealth Management, we have created MyImpact – a tool that allows our clients to better understand how they want to invest sustainably, as well as the Sustainable Development Goals (SDGs) that they wish to tackle. We can thus help them better align their portfolios to those SDGs that they wish to invest into.

When asked, our clients responded that SDG 7, affordable and clean energy, together with SDG 13, climate action – remain top of mind. These were followed by SDG 4, quality education; SDG 6, clean water and sanitation; SDG 2, zero hunger; and SDG 16, peace, justice and strong institutions. So, we can see here a good representation of E, then S and G.

What ongoing due diligence do you carry out to ensure fund managers are doing what they promised on ESG?

At BNP Paribas Wealth Management, we have developed a ‘clover rating methodology’ where we use a consistent approach – with criteria adapted to all asset classes – to position the sustainability level on a single rating scale from 0 to 10 clovers.

The clover rating measures the sustainability level of all recommended financial instruments, from stocks to bonds, to structured products, to DPM, to funds and ETFs as well as private equity and real estate funds.

It allows the comparison of all financial instruments in clients’ portfolios to best align their holdings with their sustainability objectives: we start from ESG integration, to responsible multi-sector (ESG best practices), sustainable thematic (linked to SDGs) and impact investing (highest level of positive impact to the SDGs).

Do you see ESG becoming the standard and the term no longer needing to be used?

Yes, I think it is already happening. We are seeing more and more asset managers, asset owners and investors integrating ESG into their investment and decision making processes. This is where the industry is heading, it will soon be the ‘norm’.