Update on ESG Investing: Q3 Lull, Q4 Storm?

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Update on ESG Investing: Q3 Lull, Q4 Storm?

The following graph in FactSet’s latest Earnings Insight report caught our eye; it is a count of the number of S&P 500 companies which mentioned environmental, social and governance (ESG) topics in their Q2 2020 earnings calls. One would have thought that the operating environment last quarter would have crowded out this topic in favor of green-eyeshade sorts of analysis. One would be very wrong…

Q2’s 60 companies mentioning ESG isn’t as high as Q4 2019’s 71, but it is certainly well above both Q1 and all prior periods. At one level, this makes sense given the times. But based on our decades of listening to earnings calls (we were there when they started in the early 1990s) we can tell you no issue makes it into one of these presentations without C-level management consideration. And since we are talking about the worst quarter since the Financial Crisis, the inclusion of ESG is a notable one.

We got to wondering how the popularity of ESG investing has fared in recent months. Here is the money flow data for ESG-focused exchange traded funds, comparing Q3 2020 to-date with year-to-date trends:

  • Q3-to-date ESG ETF inflows total $4.2 billion, which is a $5.5 billion quarterly run rate.
  • That is actually a touch slower than the quarterly run rate for Q1/Q2 2020, which was $7.1 billion.
  • As a share of all ETF fund flows for Q3, ESG products are 4.7% of all inflows quarter-to-date.
  • On this basis, ESG is also a less-popular investment choice than in Q1/Q2, when 7.3% of all inflows went to these products.
  • For just equity funds, ESG inflows have been 13.8% of Q3 inflows versus 20.6% for 1H 2020. This says that the decline in market share noted in the prior points is not due to differences in asset class preferences (fixed income ESG is a relatively new concept, for example).

So, ESG is losing some traction even as companies have started to talk about it more. Is this perhaps due to performance? Here are the 1 month/YTD returns for the 5 largest ESG-focused ETFs listed in the US, just over half (53%) of all such products by assets under management:

  • ESGU (iShares ESG Aware MSCI USA):
    1-month: +0.6%
    YTD: +6.3%
  • ESGE (iShares ESG Aware MSCI Emerging Markets):
    1-month: +0.3%
    YTD: -1.1%
  • ESGD (iShares ESG Aware MSCI EAFE):
    1-month: +1.2%
    YTD: -5.8%
  • USSG (Xtrackers MSCI US ESG Leaders):
    1-month: -0.6%
    YTD: +4.2%
  • SUSL (iShares ESG MSCI USA Leaders):
    1-month: 1.1%
    YTD: +4.2%

The simple message here: ESG performance has been generally good both across short time frames like the last month and longer ones like year-to-date. ESGU and SUSL have beaten the S&P 500 (+0.2% over the last month, +3.4% YTD). USSG has stumbled a bit over the last month but is still beating the 500 YTD. ESGD is outperforming the MSCI EAFE Index, which is -1.1% over the last month and -6.7% YTD. Likewise, ESGE is doing better than the MSCI Emerging Markets Index, which is -1.2% over the last month and -2.1% YTD.

We are left, therefore, to ponder why ESG fund flows have slowed in Q3 2020. Granted, we only looked at ETF inflows but these do represent a large slice of “fresh money”, both new-new investments as well as the destination for mutual fund redemptions. Our best take is that we’re in a lull before a pickup in Q4, when tax loss selling and asset reallocation causes a seasonal movement of investor assets.

Bottom line: ESG inflows may have slowed in Q3, but the narrative around them seems to still be growing based on the mentions on Q2 conference calls. Performance has been good, so we expect this investment approach to gain more traction as 2020 comes to a close.