Saving the world and earning good money at the same time? No problem, sustainability investments can do it, according to the marketing of the ETF and fund industry. Ali Masarwah, analyst and managing director of the financial services provider envestor, puts this naive understanding of ESG investing into perspective.
25. March 2024. FRANKFURT (envestor). The fund and ETF industry has a luxury problem. It is a growth industry and it wants to sell more. On the one hand, the fund industry has won the culture war against the insurance industry. ETFs and funds are the instruments of choice for long-term wealth accumulation, and that is a good thing. The low interest rate environment has presumably put an end to capital-forming life insurance, and that is definitely a good thing. (If you want to cover your biometric risk, you should invest a few euros a month in term life insurance). What is less good, however, is that the fund industry is using its dominance for gross marketing nonsense, thereby jeopardizing investor returns. It's all about sustainability investments.
Sustainable investment is one of the top priorities of global measures to combat climate change. The agreement reached at the 2015 Paris Climate Conference defined the channeling of financial resources into investments that are in line with climate protection targets as one of the most important instruments of global climate policy. Since then, sustainably investing funds and ETFs have been in high demand. Numerous ESG products have come onto the market. Demand has long been immense. In some years, 50 percent or more of all new investments in funds and ETFs were in sustainability funds. This was due not only to the altruism of climate activists, but also to fund marketing.
In the first few years after Paris, the marketing messages were still discreet. There was no evidence that ESG ETFs and ESG funds had a yield disadvantage compared to their conventional counterparts, they said. When the performance of ESG investments went through the roof in times of low interest rates, the sales messages became more full-bodied: because sustainability risks reduced the value of investments - think of the consequences of the diesel scandal for the price of VW shares - ESG strategies were instruments for managing risks. And because this avoids environmental and governance scandals, ESG investments have a systematic performance advantage, according to this narrative.
Curtain up for the year 2022! A representative comparison between the performance of the MSCI World Index and its sustainability counterpart, the MSCI World SRI, shows that the MSCI World SRI fell 4.5 percentage points behind the MSCI World. What happened?
At this point, we need to look at the characteristics of conventional and sustainable portfolios. ESG portfolios have been more heavily invested in growth stocks than the broad market in recent years. The reason for this is that IT and pharmaceutical companies, two classic growth sectors, have a better environmental balance sheet than, say, oil, gas and commodity companies. In addition, many growth companies are so-called long duration assets. Their cash flows are further away than the cash flows of said oil, gas and commodity companies, which generate their earnings in the here and now. This was an important reason why sustainability portfolios significantly outperformed conventional funds and ETFs in the years 2016 to 2021.
There is much to suggest that the performance of ESG portfolios is not due to a systematic factor that remains stable over time. In addition to the growth factor, the balance sheet quality of companies in ESG indices and the momentum factor have also supported their performance for a long time. This can always have an impact on performance, but should be classified under the headline "coincidence".
When it comes to ESG, investors should bet everything on the beginning, on the time before 2016. Because ESG investments inevitably cleanse the equity and bond universe of "dirty children" due to investors' ethical preferences, their choices are consequently curtailed. The more rigorous the ESG filter, the more companies are excluded. This can sometimes significantly reduce the relative return.
Those who want to invest sustainably express very specific preferences and values. They may voluntarily forego some returns in order to save the climate, help workers' rights achieve a breakthrough and promote rigorous ethical standards in the companies in which they invest. ESG investors should therefore not complain if the performance of their investment in a market cycle leaves something to be desired. Achieving investment success is sometimes more difficult than catchy marketing messages suggest.
By: Ali Masarwah, 25. March, 2024, © envestor.de
Ali Masarwah is a fund analyst and Managing Director of envestor.de, one of the few fund platforms that pays cashbacks on fund sales fees. Masarwah has been analyzing markets, funds and ETFs for over 20 years, most recently as an analyst at the research house Morningstar. His expertise is also valued by numerous financial media in German-speaking countries.
This article reflects the opinion of the author and not that of the editorial team of boerse-frankfurt.de. Its content is the sole responsibility of the author.
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