Ethical funds see jump in investment inflows

For some investors it is no longer enough to focus only on financial returns — many are also seeking ways to put their money where it might help achieve positive social change.

Over 70 per cent of all investors contacted by Morgan Stanley in a survey published last year said they were interested in sustainable investing. That proportion jumped to 84 per cent among millennials.

And investors are not only gathering on the sidelines and looking at investing in ethical funds. There is evidence that they are already doing so in large numbers.

Assets in US-domiciled funds classified as having an environmental, social and governance (ESG) tilt more than quadrupled between 2012 and 2014, from $1tn to $4.3tn, according to the US Sustainable Investment Forum.

Many investors still worry that they might be sacrificing investment returns by taking into account ethical factors when deciding how to allocate their money.

However, analysts believe increasing numbers of investors are being swayed by research suggesting that ESG funds are at least providing comparable financial returns to funds without an ethical theme.

“A lot of research remains to be conducted on the broad question of whether a focus on ESG leads to superior long-term performance,” says Jon Hale, head of sustainable research at Morningstar, the funds data provider.

“At the company level, there’s increasing academic evidence of that being the case,” he adds. “But once you put those ideas to work in an investment strategy, a host of other factors come into play — things like execution and fees.”

Despite the difficulties, the idea that ethical concerns do not compromise returns is gaining traction with some of the heavyweights of the investment industry.

A UBS report published last year, which included a review of over 50 articles that examined performance of sustainable investment, found a slightly larger number of studies had results which were in favour of sustainable investment.

“The overall rise in ESG investing represents a secular shift in thinking but that becomes a lot more powerful if studies come out saying ESG produces comparable or superior risk-adjusted returns,” says Chris Mason, a research analyst at Cerulli.

The evidence is compelling enough to have persuaded Morningstar to roll out an ESG-scoring scheme to accompany its existing mutual fund ratings system.

It has unveiled its first batch of sustainability scores for 20,000 funds, only some of which are explicitly marketed as ESG-friendly. The company plans to utilise the new data to help investors learn what to expect from their ESG exposures.

“It’s going to be a number of years before you can connect ESG scores with any kind of performance evaluation using our numbers,” says Mr Hale.

In the meantime, there are plenty of ESG funds available to choose from, which already enjoy endorsements from Morningstar.

Of the 20,000 funds scored on sustainability, roughly one-third received a “high” or “above average” ESG rating.