If you were around in the early 1970s and reading the New Yorker or The New York Times, you probably remember advertisements for the Pax World mutual fund. This was the first example of what we now call an environmental, social, and environmental (ESG) investment product. Pax (Latin for “Peace”) was the brainchild of 2 United Methodist Ministers who were looking to avoid investing the church’s capital in companies that supported or enabled the Vietnam War.
In 1986 the US Congress passed the Comprehensive Anti-Apartheid Act, which prohibited new American investment in South Africa as a response to that country’s racists social policies. In the 1990s, after the Exxon Valdez oil spill and with growing concern about climate change, environmental issues started to enter investment discussions. And all the way through the 1970s – 1990s, corporate malfeasance made governance a topic of increasing focus.
The point here is that ESG investing is 1) not new, and 2) grows and shifts in focus based on where social attention is most pronounced.
With that brief history lesson in mind, here are 3 points on ESG investing today:
#1: 10% of all year-to-date US-listed ETF inflows are to ESG funds, a very large uptick from historical patterns:
- YTD ESG inflows: $13.9 billion out of a total $139.0 billion for all ETFs.
- That 2020 YTD inflow number is 85% of all ESG inflows over the last 3 years ($16.4 billion).
- Equity ESG ETF inflows ($13.5 billion) represent 28% of all equity ETF inflows year-to-date.
Takeaway: while exchange traded funds are only part of the investment landscape, they are the primary destination for new retail investor flows so seeing ESG-related funds take in so much capital in 2020 shows this theme is now catching a very large tailwind. We can recall looking at this data over the last 2 years and wondering when ESG would take off. Now we know: that time is now.
#2: Unlike the ETF ecosystem generally, most ESG funds are gaining assets this year although the big are certainly getting bigger:
- There are 78 US-listed ETFs that use an ESG investment framework.
- 60 of them have seen YTD inflows.
- Two thirds of total 2020 YTD ESG ETF inflows have gone to just 3 iShares products: one for US equities, one for Emerging Markets, and one for EAFE stocks.
Takeaway: even with this growth, the largest US-listed ESG ETF in terms of assets under management (ESGU, the iShares US equity product) is still only a $7 billion fund. That means it’s not even in the top 100 largest ETFs. There is room to grow…
#3: Three thoughts on why the increasing popularity of ESG investing matters more generally:
- At the margin it increases money flows into equities generally and index-based investing specifically. It’s hard to know where the $14 billion of YTD ETF inflows would have gone if there were no ESG funds, but we assume some would have stayed in cash or gone into single stocks that asset owners felt fulfilled their ESG mandate.
- ESG funds actual own Energy stocks, so don’t worry that their rising popularity will lead to lower access to capital for this group. ESGU has 0.6% in both Chevron and ExxonMobil, for example. ESGE – the iShares Emerging Markets ESG product – has a 1.0% position in Lukoil and 0.5% in Gazprom, just to name 2 Energy stocks in the portfolio. And ESGD (EAFE ESG) owns BP (0.9% weight) and Total (0.9% as well).
- This leads to a logical question: what exactly is ESG investing anyway? Can an ESG fund really own a market weight in Energy? Should an EM ESG fund own Tencent (ESGU weighting of 6.6%) as long as its users’ data is freely available to the Chinese government? Hard questions all.
Takeaway: with growth comes responsibility, and nowhere more than investment style whose objective is to allocate capital in a socially responsible manner. Don’t get us wrong – we like the idea very much. But we also know this approach has many more challenges ahead than when 2 Methodist ministers invented it 50 years ago.