ESG Navigator June 28, 2022
The world of investing is continuously innovating. Countless strategies, models, systems have left their marks in the investment world. ESG (Environmental, Social and Governance) investing is now well on track to becoming mainstream. The ESG factor will help reshape the global economy as stakeholders have become increasingly aware that ESG decisions can help in creating value for a business over the long term.
The ESG umbrella covers issues, ranging from climate change to human rights and quality of company management. In the current tech-dominated world, consumers are becoming increasingly cognizant of business sustainability and demanding higher standards. ESG investing offers the potential to create opportunities that can achieve a triple bottom line of good investment returns and positive social and environmental impact.
ESG reshaping Global Asset Management
Source: Bloomberg Intelligence
Global ESG assets surpassed USD 35 trillion in 2020 and are expected to exceed USD 41 trillion by 2022 and USD 50 trillion by 2025, which is approximately one-third of the projected USD 140 trillion in total assets under management globally2.
According to Bloomberg Intelligence, Europe held more than half of the global ESG assets until 2018, where it was surpassed by the US, which now dominates with over 40% growth in the past two years. The US has emerged as a leader in ESG assets, and progressively an increasing number of fund managers have devoted significant marketing drives to ESG funds over the recent years. As a result, the global market is now fuelled by ESG awareness and uptake.
ESG grabs 10% of Global ETF Flows
Source: Refinitiv Lipper Data
According to Refinitiv Lipper data, global ETFs received a record USD 1.22 trillion in inflows last year (2021), which was about 71% higher than 2020. The US ETFs were the biggest recipients, receiving USD 901 billion, while European and Asian ETFs drew about USD 190 billion and USD 88 billion respectively3. Meanwhile, the exponential growth of ESG ETFs has been truly staggering. Global ESG ETFs secured USD 119.4 billion in 2021, which accounted for about 10% of the total USD 1.22 trillion global ETF flows.
Step-by-step guide for ESG investing
Source: Refinitiv Lipper Data
ESG investing has exploded in popularity in recent years, but investors may wonder if ESG is just a passing fad or here to stay? Before dealing with the question, let’s first go through 3 key stages that incorporate ESG considerations across each decision level to help you simplify the product selection process, when choosing an organisation that will fit into your green portfolio.
Stage 1: Qualitative Analysis
- Target companies and sectors of your investment interest.
- Apply ESG screening to exclude “sin stocks” and to identify stocks integrated with ESG principles
- Assess quality of company management, business strategy and alignment to ESG objectives
Stage 2: Quantitative Analysis
- Gather numerical information to narrow down a collection of stocks to a manageable list
- Credit rating agencies such as Fitch Ratings, S&P and Moody’s do not provide ESG ratings scores but they do consider ESG factors when making their credit rating decisions.
- ESG rating agencies outline scorecards to compare against the output from the materiality assessment.
Source: Fitch Learning
Stage 3: Investment Decision
- Investment timeframe: long term or short term?
- Understand risk appetite and risk tolerance
- Construct the best fit asset allocation and portfolio weight
Here is an example to demonstrate the 3-stage process
Step 1: ESG screening & filtering
|Target Sector||Target Companies|
Step 2: Quantitative Analysis
- Based on MSCI ESG Ratings, General Motors may warrant a higher relative valuation than Ford as investors will be attracted to a company with a superior ESG rating.
- General Motors has shown dedicated progress in terms of ESG ratings and has met the industry average in a recent assessment in Sept 2021. In contrast, Ford has remained in the “Laggard” group for 5 consecutive years. Conclusively, you can see that General Motors has been consistently integrating principles of sustainability and corporate social responsibility into its business and management systems.
Source: MSCI ESG4 5
- Taking into account the Price to earnings ratio (P/E) as a metric for the relative valuations of these 2 companies, it can be seen that General Motors has a higher P/E ratio score (6.09) compared to Ford (4.63)7.
Source: Yahoo Finance, as of 10 June 2022
Step 3: Investment decision
The market may find that General Motors (with higher P/E) has lower risk and better opportunities for growth in the future. Is this perhaps, due to the higher ESG score? It is evident from this example that there is a positive correlation between ESG scores and the relative valuation of a company. However, it is important to note that there are many other factors that investors will need to consider when valuing General Motors relative to Ford as well.
Due to potential profits that companies can achieve from fronting ESG integration, greenwashing has emerged as its evil twin. Greenwashing is considered an unsubstantiated claim to deceive consumers into believing that a company’s products are environmentally friendly8.
Here are some reasons why companies go for greenwashing
- Investors’ demand outweighs ESG supply
- Lack of regulated and standardised ESG guidelines on a global scale
- ESG-linked ideas enjoy more incentives and public favour
Individual investors can take the steps below to keep an eye out for greenwashing
- Obtain ESG ratings only from trusted and authorised sources
- Understand how funds integrate ESG considerations into their investment process
- Know what is in your ESG portfolios and asset allocations
- Seek the advice of a professional or financial consultant who will help you better understand ESG-linked products
In such a volatile market, what hurts ESG ETFs? What helps?
In recent years, flows and growth of ESG ETFs have remained concentrated and signs of an expanding investor base are emerging. Some investors may wish to quickly gain ESG portfolio exposure but face time constraints when managing their stock picks. Given the wide variety of ESG-integrated methodologies available, ESG ETFs are able to provide investors with easy and diversified exposure to their desired market segments.
Source: Bloomberg Intelligence
The current market is experiencing unprecedented turbulence and unpredictability amidst the rising interest rates and geopolitical tension. As indicated in the chart above, ESG and values-based ETFs dropped about 2% to USD 453 billion in Q1 this year. The rate of inflows may continue to face challenges particularly from funds with high levels of technology holdings.
Furthermore, when it comes to growth patterns, concentration risks may persist. This could challenge the market going forward. Many ESG ETFs have achieved their size through funding with one or more large shareholders rather than through organic growth. According to Bloomberg data, ESG ETFs’ top holders have about 25% of the funds on average. Therefore, when there is a large fund outflow by one main shareholder, it is likely to raise questions about the sustainability of growth.
Source: Bloomberg Intelligence
While concentration risks exist, the one thing we are starting to see is signs of easing. Currently, 10 funds account for about 22% of flows, but this is down from 58% in 2017 as shown in the figure above. These signs of easing are great for long-term growth.
Source: Bloomberg Intelligence
According to the Bloomberg ESG ETF flow tracker, the consistently increasing inflow to different sustainability themes paints a good picture of market demand. We see from the chart that flows to clean energy haven exponentially increased by about 18 times in 2021 compared to 2019.
As 2025 approaches, many ESG-transitioning companies’ investments under different themes could start to pay off and expand the eligible pool of stocks. In addition, increased scrutiny to ensure both corporate and government net-zero targets are on track and should support various ESG themes and help the market achieve scale and maturity. A more diverse investment universe combined with a broader and larger investor pool should help the market grow and tame the volatility linked to concentration, liquidity and regulatory risks.
At Phillip Securities, we are keenly aware that the ESG investing space is complex and nuanced. We evaluate investment opportunities through multiple lenses to gauge if they meet the needs and aspirations of different stakeholder groups. For investors who are interested in ESG ETFs, you may check out our Phillip ETF Screener for the most established and actively traded ETFs. You can key in ESG under the Fund Name search tab and filter by key financial indicators and product classification based on your investment interests.
Source: Poems ETF Screener
To round up
Despite the uncertain macro environment, most of the management team of the companies featured in this article are optimistic of the near future. However, the Federal Reserve committee does not share the same sentiment and is greatly concerned with inflation as can be seen from the latest meeting.
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-  https://www.valueresearchonline.com/stories/49015/the-rise-of-esg-investing/
-  https://www.bloomberg.com/company/press/esg-may-surpass-41-trillion-assets-in-2022-but-not-without-challenges-finds-bloomberg-intelligence/
-  https://www.reuters.com/markets/europe/global-markets-etf-graphic-2022-01-21/
-  https://www.msci.com/research-and-insights/esg-ratings-corporate-search-tool/issuer/general-motors-company/IID000000002433496
-  https://www.msci.com/research-and-insights/esg-ratings-corporate-search-tool/issuer/ford-motor-company/IID000000002166799
-  https://finance.yahoo.com/quote/GM?p=GM&.tsrc=fin-srch
-  https://finance.yahoo.com/quote/F?p=F&.tsrc=fin-srch
-  https://circoax.eu/greenwashing
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About the author
Zi Han is a Day Desk Equity Dealer in the Global Markets Team. She specializes in China, HongKong and South East Asian Markets. She graduated from Nanyang Technological University with a Bachelor's Degree in Material Science and Engineering.