Interest in sustainable investing has been growing as climate-related policies creep up governments’ agendas, and there has been more demand for companies to improve their social and governance standards. But there has been a longstanding debate as to whether a focus on sustainability, which includes environmental, social and governance (ESG) factors, in investing comes at the expense of performance. However, funds that aim to, for example, help combat climate change, preserve the environment, and or promote corporate responsibility, have held up better than their conventional counterparts over the past three months – and analysts believe this trend is set to continue.
Wealth manager Charles Stanley examined the average performance of funds marketed as ethical, socially responsible and sustainable in the Investment Association (IA) UK All Companies and Global sectors. There are 34 Global and 22 UK All Companies sector funds that have a socially responsible investment (SRI) strategy, up from 11 and 19, respectively, 10 years ago. The performance average is calculated according to the number of funds available in each year.
| UK All Companies funds | 3-month total return (%) | 1- year total return (%) | 3-year cumulative total return (%) | 5-year cumulative total return (%) | 10-year cumulative total return (%) |
| SRI funds average | -9.2 | -5.9 | 0.9 | 15.4 | 114.7 |
| Non-SRI funds average | -11.9 | -11.4 | -8.9 | 5.9 | 94.3 |
| FTSE All-Share index | -9.8 | -11.6 | -7.8 | 7.3 | 81.7 |
| Global funds | 3-month total return (%) | 1-year total return (%) | 3-year cumulative total return (%) | 5-year cumulative total return (%) | 10-year cumulative total return (%) |
| SRI funds average | 1.8 | 10.8 | 28.4 | 52.8 | 132.6 |
| Non-SRI funds average | -0.6 | 4.6 | 16.5 | 50 | 155.3 |
| MSCI World index | 4 | 7.7 | 23.8 | 64.6 | 185.2 |
| Source: Charles Stanley using FE Analytics data as at 22 May 2020 |
The reasons for this outperformance may include the fact that the coronavirus pandemic has exacerbated existing trends such as a rise in demand for technology, greater investment in healthcare and falling demand for fossil fuels. Sustainable funds tend to be overweight technology and healthcare stocks, which have performed well on a relative basis over the crisis. And few sustainable funds invest in oil and gas companies, or airlines, which have been among the worst-performing stocks as the price of oil has fallen sharply and restrictions on movements have massively reduced the number of passengers flying.
These performance drivers look likely to continue over the long term as governments set tough carbon emission reduction targets and more scrutiny is placed on companies' social responsibility. Colin Low, managing director of Kingsfleet Wealth, is trying to transition his clients into sustainable funds because he believes that they have better long-term performance prospects. “We prefer their longer-term approach [relative to conventional funds],” he explains.
Julia Dreblow, director of SRI Services and founder of Fund EcoMarket, also thinks that the pandemic has sharpened focus on the social side of companies, and that those that have treated staff and suppliers well should be better equipped to deal with future issues. “Companies that have treated staff badly will see quite a bad hit, and emphasis on social policies such as flexible working will become more important,” she adds.
What to be aware of
The world of sustainable investing is tough to navigate as terms such as ‘ethical’, ‘responsible’ and ‘sustainable’ mean different things to different people, and there are no common definitions. However, there are some trends.
Funds that describe themselves as ‘ethical’ tend to actively avoid companies or industries that have a negative impact on society and the environment. Companies involved in areas such as tobacco, animal testing, gambling, and oil and gas are likely to be excluded from ethical funds.
Funds marketed as 'sustainable', meanwhile, try to select companies that have a positive impact. This could include ones a variety of areas such as green technology and social initiatives, and even oil companies that also invest heavily in clean energy.
Ms Dreblow says that although there is a lot of variation between sustainable funds they tend to share a high level aim of “a greener, cleaner future”. But some might invest in companies making sustainable products such as renewable energy, while others might seek companies that are leaders in their sector on ESG credentials – even if the business model is not based on sustainable solutions. Some of these funds also engage with companies to try and improve them.
So, as when choosing any kind of fund, you need to do due diligence and make sure you are comfortable with what you are buying. This is particularly necessary with ESG funds because asset managers have been accused of just using ESG as a marketing tool and not having a very authentic sustainable investment approach.
Hortense Bioy, director for passive strategies and sustainability research in Europe at Morningstar, suggests selecting a fund with experienced managers who have been investing via a sustainable investment approach for a number of years. This will help you avoid investing in a fund that does not have an authentic process.
Another risk is the potential for a bubble. Analysis from Morningstar shows that in the first quarter of this year European sustainable funds attracted €30bn (£26.91bn) of inflows in contrast to €148bn of outflows suffered by the overall European fund universe. If money continues to flow into stocks deemed sustainable there is a risk of a bubble forming. There are already concerns that the share prices of big US tech stocks are becoming over inflated and these are widely held by sustainable funds.
However, Mr Low thinks that it is unlikely sustainable active funds will have exposure to overpriced assets as their managers are selective, but this is a higher risk for sustainable passive funds.
Sustainable fund options
Regardless of your ethical preferences, the chances are you don’t want to sacrifice performance. So a sustainable fund that has performed well so far this year is Baillie Gifford Positive Change (GB00BYVGKV59), which Rob Morgan, pensions and investments analyst at Charles Stanley, says “completely dispels the popular myth that a socially responsible fund can never be a top-notch performer”. The fund is a high-conviction, concentrated portfolio of growth stocks and has low turnover of its holdings, meaning that trading costs eat less into returns. The fund aims to contribute to a more sustainable and inclusive world while generating strong returns by investing in four impact themes. These are social inclusion and education, environment and resource needs, healthcare and quality of life, and companies that address the basic needs of the poorest people.
Ryan Hughes, head of active portfolios at broker AJ Bell, thinks that Stewart Investors Worldwide Sustainability (GB00B7W30613) could be a good option for investors who are new to sustainable investing. Its managers have a long record of investing in this way, and the fund invests globally, aims to avoid capital losses by investing in high-quality companies and takes a long-term view.
If you want a fund that excludes certain areas, one option with a strong performance record is Liontrust Sustainable Future Global Growth (GB0030030067). Tim Cockerill, investment director at Rowan Dartington, suggests this fund because its managers are very experienced, and have a strong performance record and conviction in their investment process. The fund holds about 50 stocks, and technology and healthcare companies account for over 50 per cent of its assets.
If you are looking for a more thematic approach, FP WHEB Sustainability Fund (GB00B8HPRW47) focuses exclusively on companies that provide solutions to environmental and social challenges. Over 20 per cent of the fund's assets are in companies involved with resources efficiency, and over 10 per cent in companies that facilitate sustainable transport. Unlike many other SRI funds, the managers list all 50 stocks held by this fund on their website.
Emma Bird, research analyst at Winterflood, likes Impax Environmental Markets (IEM). This investment trust has performed well and has a market capitalisation of about £738m, so it has good secondary market liquidity. Its managers, Bruce Jenkyn-Jones and Jon Forster, have considerable experience of investing in environmental equities and are supported by the wider team at Impax Asset Management, which has offices in the UK, US and Hong Kong.
UK equities sustainable funds include Royal London Sustainable Leaders (GB00B7V23Z99). The fund has significantly outperformed the IA UK All Companies sector average over five years, and aims to invest at least 80 per cent of its assets in the shares of UK-listed companies that make a positive contribution to society.
Income investors could consider renewable energy infrastructure trusts for an attractive yield. Kieran Drake, analyst at Winterflood, suggests Greencoat UK Wind (UKW), which has a strong performance record, a yield of 5 per cent and one of the highest dividend cover levels among this kind of trust. Wind speeds in the first quarter of this year were above average so should provide a boost to revenues for this wind-focused fund, helping to compensate for the lower power pricing exacerbated by the Covid-19 pandemic, according to Dr Drake. However, some trusts in this sector are trading at large premiums to net asset value (NAV), which could fall if the sector goes out of favour or a given trust does not perform well going forward. Greencoat UK Wind, for example, was trading at a premium of 17.9 per cent at close on 29 May.
