What do the major ESG funds offer?

Investors in sustainable global equity funds have every right to feel disappointed following a challenging first half of the year. A typical sustainable global fund has lost 16.7 per cent over the past 12 months, slightly underperforming mainstream rivals' average loss of 16.6 per cent, according to Morningstar’s data.

Five of the UK’s best-known sustainable funds have fared even worse, with an average loss of 17 per cent over the period. These are Baillie Gifford Positive Change (GB00BYVGKV59), Ninety One Global Environment (GB00BKT89K74), Liontrust Sustainable Future Global Growth (GB0030030067), FP WHEB Sustainability (GB00B8HPRW47) and Impax Environmental Markets (IEM).

In large part, this will be down to the ‘growth’ bias adopted by a number of the fund managers, as well as an inclination or, in some cases an obligation, to steer clear of industries such as oil and gas or mining that have rallied hard of late.

Some of these funds invest in line with environmental, social and governance (ESG) criteria, and choose to exclude certain sectors as a result. Others target companies which have the potential to deliver a positive impact socially or environmentally.

Below we have summarised the processes and quirks of some of the UK’s biggest and best-known sustainable global equity funds.

'True' sustainable funds

John Ditchfield, founder of Impact Lens, which provides research on ethical and sustainable funds, describes Impax Environmental Markets and FP WHEB Sustainability as “the best examples of truly sustainability-focused funds”.

“I would describe Impax and WHEB as being committed to the pursuit of a more sustainable economy in a way that Baillie Gifford Positive Change simply isn’t,” he says.

Both funds focus on impact, which puts a greater focus on producing measurable social or environmental benefits rather than just financial gain.

“WHEB and Impax invest heavily in solutions companies, for example, those that are enabling the energy transition,” says Julia Dreblow, founder of SRI Services, a sustainable and responsible investment consultancy.

This is also a feature of Liontrust Sustainable Future Global Growth, although these companies make up a smaller proportion of its portfolio.

“When you look at the sector, you will always find underlying companies in portfolios that are a bit plain vanilla. However, this won’t be the case for WHEB and Impax,” Dreblow explains.

Fund performance – cumulative total returns (%) to 23/06/22

Source: FE

FP WHEB Sustainability and Impax Environmental Markets also stand out because of their focus on impact measurement and reporting. They seek to quantify the real-world impact of their investments, for example, in relation to net carbon benefits.

FP WHEB Sustainability’s managers favour high-growth businesses, typically mid and large caps, with a preference for sectors and themes that promise good returns but remain under appreciated by other investors. Its four largest competitors typically invest in larger companies.

FP WHEB Sustainability’s managers focus on businesses involved in the transition to “healthy, low-carbon and sustainable economies”, with the portfolio broken down into nine different themes. These include five environmental themes (cleaner energy, environmental services, resource efficiency, sustainable transport and water management) and four social themes (education, health, safety and wellbeing).

Over the past year, the fund, which has assets worth £829mn, is down 15.4 per cent. Meanwhile, over three and five years it has returned 8 per cent and 23 per cent, respectively.

The investment trust option

As the £963mn open-ended Impax Environmental Markets (IE00B04R3307) fund is ‘soft-closed’ so unavailable to new investors, its investment trust equivalent offers a good alternative. It has the same name and a similar strategy, although its shareholders must be prepared for potential share price volatility.

Impax Environmental Markets recently traded on a 3.4 per cent discount to the value of its underlying assets. Over the past year, its share price has fallen by 17.7 per cent. However, three- and five-year numbers have been robust, with respective share price returns of 28.9 per cent and 69.1 per cent. It has a market capitalisation of £1.2bn.

Its managers target innovative small- and mid-cap companies which provide solutions to resource scarcity, ageing infrastructure, climate change and energy security, with seven underlying themes. As the name suggests, its main focus is on the environment so it does not cover social challenges like FP WHEB Sustainability does.

Focus on decarbonisation

Similarly, Ninety One Global Environment fund, which has assets worth £1.8bn, should appeal if you are particularly concerned about the environmental challenges the world faces.

Unlike Impax Environmental Markets, it has a much narrower focus on decarbonisation. Its managers invest in companies that offer environmental solutions to resource efficiency and renewable energy, which can also demonstrate a measurable reduction in carbon emissions. They believe that these companies will benefit from a multi-year tailwind from global efforts to lower emissions.

Over the past year, the fund is down 7.3 per cent. It has the most concentrated portfolio of this sub-group with only 24 stocks.

Tertius Bonnin, an assistant portfolio manager at EQ Investors, describes Ninety One Global Environment as a “long-term favourite” and believes that there is a case for holding it alongside Impax Environmental Markets in portfolios.

“You can expect some overlap between the strategies but there is no problem in holding the two together,” he adds.

A broader approach

Baillie Gifford Positive Change has been an incredibly popular option among investors and has £2.6bn under management. However, relative to its four biggest peers, it has delivered the biggest loss of 28.5 per cent over the past year. This is largely down to its out-and-out growth style, which has struggled since the sell-off took root late last year. Over three and five years the fund is up 53.8 per cent and 108.1 per cent, respectively.

Unsurprisingly, it has been the most volatile fund over the past 12 months versus its biggest peers, with a standard deviation of 26.3, according to Morningstar. This tells you how much the fund has strayed from its expected return. The average standard deviation across this sub-group of funds was 19.8.

“This is a pretty racy fund,” explains James Clark, a senior fund analyst at Hawksmoor Investment Management. “This is not for widows and orphans. Until the recent pullback, it was easy to forget that. I wonder how many people have invested at the top of the market without realising what they were getting themselves in for.”

Baillie Gifford Positive Change's managers focus on companies which have the potential to deliver positive change in relation to the environment and resource scarcity; social inclusion and education; healthcare and quality of life; and addressing the needs of the world’s poorest populations. This helps to explain the fund’s broader appeal for investors.

Baillie Gifford Positive Change could be viewed as an outlier compared with its larger peers on account of its willingness to hold stocks that competitors typically shun, Tesla (US:TSLA) being a prime example. The electric vehicle manufacturer has been criticised for its working conditions and approach to corporate governance.

“Baillie Gifford Positive Change has a 4 per cent holding in Tesla, despite the environmental impact of lithium extraction and [the company's] often wayward corporate governance,” says Mr Ditchfield.

However, Baillie Gifford argues that Tesla has a significant role to play in reducing climate change by increasing the adoption of electric cars, which are more environmentally friendly than combustion engine vehicles.

This willingness to hold stocks that may be deemed contentious by others comes down to the fund's managers’ preference for considering both the negatives and the positives of each company and to then look at the overall net positive impact.

As Baillie Gifford has a trademark growth style and a collegiate approach, there is inevitably some overlap between Baillie Gifford Positive Change's holdings and those of the fund house’s other well-known funds. For example, Moderna (US:MRNA), ASML (NV:ASML) and Taiwan Semiconductor Manufacturing (TAI:2330) also appear in the Scottish Mortgage (SMT) and Keystone Positive Change (KPC) investment trusts. This is not a concern for Mr Bonnin, who currently holds Baillie Gifford Positive Change on behalf of clients.

“I think Baillie Gifford Positive Change is differentiated enough," he says. "Scottish Mortgage has an association with tech morphed into consumer-based stocks and these won’t appear in the same weighting in Positive Change. You are not going to find the likes of luxury goods manufacturer Kering (FR:KER) in the Positive Change fund, for example."

The all-rounder

Liontrust Sustainable Future Global Growth, which has assets worth £1.9bn, also focuses on a broad range of areas covering the environment, education and healthcare, with 18 underlying themes. These include digital security, improving financial resilience and the monitoring of supply chains. It has the broadest approach compared with its four biggest peers.

While these themes guide stock selection, its managers go beyond Baillie Gifford by assessing how well ESG factors are managed and how sustainable a company’s overall activities are. They have more of a focus on negatively screening stocks and are comfortable excluding sectors like airlines or oil and gas stocks.

“For those who want certainty that [certain] sectors and industries will definitely not appear in the portfolio, this is a good option. It is an all-rounder in this space,” Clark adds.

Dreblow also points out that as well as looking at long-term sustainability, the fund's managers consider impact measurement, albeit to a lesser extent than FP WHEB Sustainability or Impax Environmental Markets.

As with its competitors Liontrust’s growth bias has resulted in disappointing performance figures, with the fund down 18.9 per cent over the past year. It is up 19.9 per cent and 58.9 per cent, respectively, over three and five years.

Old hands vs new entrants

A final point to consider is the management group behind a fund. Is it an established player in sustainable and ESG investing or a relative newcomer? In Bonnin’s opinion, having a long track record is not the be-all and end-all.

“Aviva, for example, has almost come out of nowhere," he says. "It has invested a huge amount of resource and hired really experienced people. It was not known as an impact house, but it has caught up considerably.”

However, Dreblow does not agree. She believes that there is much to be said for heritage and experience.

“The newer entrants won’t have had their fingers burnt," she concludes. "More established investors will be better at handling greenwashing by companies."