InvestmentsJul 21 2017

Ethical funds attract record money and high returns

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Ethical funds attract record money and high returns

Exchange traded funds (ETFs) that track companies with good environmental, social and corporate governance (ESG) metrics have gone from strength to strength in recent years, according to analytics firm IHS Markit.

The research company's ETF analytics database saw a record $950m (£731m) of assets invested into SRI funds in 2016.

According to the firm, 2017 is shaping up to be an even better year for SRI, with investors shifting more than $800m (£615m) to socially responsible funds year to date, propelling their assets under management (AUM) above the $5.5bn (£4.2bn) mark.

Simon Colvin, research analyst at Markit said: “These large investments come from both sides of the Atlantic, but European investors are more eager to invest with a conscience. Interestingly, at the start of 2016, socially responsible ETFs in Europe had less than half the AUM of their North American counterparts, but Europeans have contributed roughly 60 per cent of the new inflows since then.”

Markit‘s signals integrated ESG Rating, which ranks compliance to the Principles for Responsible Investment framework, shows that investors haven’t foregone returns by investing in socially responsible strategies over the last five years.

The top 10 per cent of North American shares by ESG Rating represent the best performing end of the market returning 1.24 per cent a month on average, nearly a third more than the 0.94 per cent all of North American shares since 2012.

Mr Colvin said short sellers are much less sceptical of stocks that score well with socially responsible metrics.

“The current group of North American shares in the top 10 per cent of the ESG Rating have, on average, 1.8 per cent of shares out on loan. This figure is less than half of that seen worldwide.”

Short selling is the sale of a security that is not owned by the seller, or that the seller has borrowed. Short selling is motivated by the belief that a security's price will decline, enabling it to be bought back at a lower price to make a profit.

But Mr Colvin said scoring well on ESG metrics isn’t a cure all against short sellers.

“Plenty of short targets are still present among high scoring firms. This short selling is more likely driven by company specific forces than the fundamental sector vulnerability that has made some pure play socially responsible firms the favourite short targets of the last decade.”

Mr Colvin gives the example of Hanes Brands, the socially responsible clothing manufacturer, as the top target, with more than 17 per cent of its shares shorted, despite scoring in the fourth percentile of the ESG Rating.

“Its current high short interest reflects the headwinds in North American retail and revenues,” he said.

Darius McDermott, managing director at Chelsea Financial Services emphasises that with anything ethical, the way stocks are screened is key and selection depends on what the manager of a fund is looking for.

He said: Most ESG products will take a couple of views, one, best in class or two positive/negative targeting.

"Best in class will look for the companies with the best ESG considerations vs their peers and will not discriminate against sectors (ie responsible drug companies, those who don't test on animals or have pollution histories).

"Positive or negative targeting will either remove companies they don't like (typically tobacco, arms etc) or actively select those they do (water filtration, care homes etc).

“Therefore, it is important to understand how your fund determines what is or isn't ethical.

"For this fact, we like SLI UK Ethical for its excellent shareholder engagement on what they want to see included/excluded and EdenTree Amity UK for the exceptional forward looking and deep dive considerations on what firms do.”

Since ETFs have entered more mainstream investing, downward pressure on unit trust and OEIC fees from index tracking funds has been noticeable, to the advantage of investors, according to Andrew Moore, investment director and partner at Alexander Beard Wealth.

He said: “The level of reporting environmental, social and corporate governance standards is improving steadily and a number of investment house have made a commitment to consider these factors in all aspects of their fund management process across the board not just in SRI funds.

“But the reality of ethical standards is that there will always be shades of grey. It is not a simple task to divide stock into those which have ESG and those that do not.

"Investors need to decide where they want to draw the line in respect of issues they care about - equal pay, research into green energy, operations in politically unstable countries for example.

“When it comes for performance and risk it tends to be easier for small and mid-cap firms to apply ESG standards and hence SRI portfolios tend to be tilted towards the more volatile stock. When times are good they look great, but they can also underperform in bear markets.”