As investors look for alternative ways to diversify a traditional portfolio of stocks and bonds, some have turned to the environmental, social and governance, or ESG, theme along with related ETFs.
On the recent webcast (available on demand for CE Credit), Dipping Your Toe into the ESG Waters, Abdur Nimeri, Senior Vice President and Senior Investment Strategist at FlexShares, said that there is growing demand for ESG and other sustainable investments in the U.S.
As of 2016, the market size of sustainable, responsible and impact investing in the U.S. was $8.72 trillion or one-fifth of all investment under professional management. Between 2014 and 2016, U.S.-managed assets identified as incorporating a sustainable investment approach expanded by 33%.
Sustainable investments have been slowly gaining momentum among the investment community as more investors look for alternative ways to diversify portfolios and still enhance returns. There were 55 investment funds based on ESG factors with $12 billion in net assets under management in 1995. As of 2016, there were 1,002 fund strategies with $2.6 trillion in assets, and the numbers are still growing.
“Globally, there are now $22.89 trillion of assets being professionally managed under responsible investment strategies, an increase of 25 percent since 2014. In all the regions except Europe, which tightened its definition of sustainable investing, sustainable investing’s market share has grown. In relative terms, responsible investment now stands at almost 26 percent of all professionally managed assets globally,” Nimeri said.
Given the size and scope of the U.S. markets, U.S. investors remain underallocated to sustainable investments when compared to other regions. Specifically, the growth of sustainable investing assets in the U.S. grew to $8.7 in 2016 from $6.7 trillion in 2014. In comparison, growth of sustainable investing in Europe expanded to $12 trillion in 2016 from $10.8 trillion in 2014.
According to a recent survey conducted by Morgan Stanley Institute for Sustainable Investing and Cerulli Associates, sustainable investments are the most popular among millennials. On the other hand, most financial advisors exhibited little or no interest to the investment theme as many cited the perception of historical negative performance as a major deterrent.
Nevertheless, academic studies have shown that sustainable investments like ESG integration have resulted in improved risk-adjusted returns. Nimeri pointed to a recent Oxford University study that revealed 88% of research showed effective management of ESG issues results in better operational performance of companies.
For those interested in including an ESG theme into a diversified investment portfolio, the FlexShares STOXX US ESG Impact Index Fund (NasdaqGM: ESG) and FlexShares STOXX Global ESG Impact Index Fund (NasdaqGM: ESGG) allow retail investors to easily access an institutional-level investment strategy.
The funds are based on the STOXX global ESG Impact Index, which screens companies scoring better with respect to a select set of ESG key performance indicators (KPIs), with the bottom 50% of such companies based on their ESG KPI scores excluded from the Index, as are companies that do not adhere to the UN Global compact principles, are involved in controversial weapons or are coal miners. The resulting indices provide positive risk-adjusted return characteristics and improve diversification via style and sector neutrality.
“We believe this fund can serve as a core blend equity allocation appropriate for broad equity market exposure,” according to FlexShares.
Financial advisors who are interested in learning more about ESG investments may watch the webcast here on demand.