In April 2019, the S&P Dow Jones Indices launched the S&P 500 ESG Index, an index that maintains similar industry groups as the S&P 500 while excluding companies that do not meet the sustainability criteria. Nowadays, the number of institutional as well as retail investors who look to allocate their capital in ESG areas are on the rise.
According to data by Morningstar, the estimated net flow to U.S. open-end and exchange-traded funds (ETFs) in the first quarter of 2019 was $4.1 billion, significantly higher than the net flows in the first quarter of 2018 and 2017 of approximately $1.7 billion and $1.3 billion, respectively.,.
During the MSCI’s annual investing conference this year, more than a third of asset managers and pension funds said that ESG-related assets are expected to go from 25 percent of global assets to between 50 and 65 percent in the next five years.. The figures and statistics provided show that demand for ESG investments is increasing, but they do not explain the increase in demand. Here are three reasons why we believe ESG investing is becoming a mainstream concept.
Demographics Are Changing
We are likely to see a big shift in the profile of investors due to the changing demographics in the next five to ten years. According to the U.S. Census Bureau, millennials, or people who are born between 1981 to 1996, are expected to surpass the Baby Boomers in 2019. We are seeing significant wealth transfers to millennials and women. According to data from Boston Consulting Group, private wealth held by women grew from $34 trillion to $51 trillion between 2010 and 2015 and is expected to be $72 trillion, or 32% share of all private wealth by 2020. Deloitte estimates that millennials could have access to $24 trillion in private wealth by 2020.
Millennials and women are looking to align values with their investments and more likely to invest in sustainable and impactful business models. In a survey conducted by BlackRock, they found that 67% of millennials wanted investments to reflect their social and environmental values. For women, the number is even higher at 76%.
ESG Investment Returns Are In-Line with Returns of Traditional Investments
Investors often question if they have to sacrifice their financial goals and returns in order to pursue ESG investment strategy. Data from BlackRock Investment Institute show that ESG equity portfolios have the potential to deliver comparable returns or only slightly underperform a traditional market portfolio over a short term period and to outperform over longer time periods. In addition, the data also suggest that ESG-focused portfolios offer some buffer against market volatility.
Big Data Is Changing The Way Investors Construct ESG Portfolios
. The traditional way to construct an ESG portfolio is to aggregate key words and then assign ESG ratings to screen out investments with material ESG issues. However, humans cannot simply go through all of the data available out there. This is where technology steps in; the machines can prioritize certain words and phrases above others, cross reference between different sources, and signal to investors the potential risks.
Companies are also increasingly exaggerating the green credentials of their businesses, a practice known as “greenwashing.” Even with voluntary disclosures, companies are not showing investors the full picture. According to research done by MSCI, fewer than one percent of companies in the autos, pharmaceuticals and food industries disclose information on product safety recalls and between 17 percent to 54 percent issuing comments on only a few incidents. From the graph below, we can see that the majority of product safety recalls are identified through text mining and machine learning.
Up until this point, data around ESG issues are relatively unstructured. As artificial intelligence and machine learning technology keep evolving, asset managers may be able to aggregate and analyze a significant amount of ESG data and identify investments that align with the interests of all stakeholders.
Are you considering ESG investments for your portfolio? Feel free to contact North Capital team for more information.
Disclaimer: All information provided herein is for informational purposes only and should not be relied upon to make an investment decision and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. Readers are recommended to consult with a financial adviser, attorney, accountant, and any other professional that can help you understand and assess the risks associated with any investment opportunity. Past performance is not indicative of future results. Private investments are highly risky and illiquid and are not suitable for all investors.
1 These statistics are based on Morningstar’s estimated net flows into 286 open-end and exchange-traded funds that are available to U.S. investors, all of which thoroughly integrate ESG into their investment process, and/or pursue a
sustainability-related theme, and/or seek measurable sustainable impact alongside financial return. This universe does not contain funds that employ only limited exclusionary screens without a broader emphasis on ESG, nor does it contain the growing number of funds that now acknowledge that they consider ESG factors in a limited way in their security selection