While economic, social, governance (ESG) investing is nothing new, the rapid growth of this once niche sector certainly is.
Back in the 1950s, ESG went by the acronym SRI, which stands for socially responsible investing. It was born from investors' desires not to support so-called sin shares. Mainly companies involved in alcohol, tobacco, gambling, or…gasp…adult entertainment.
In more recent years, as concerns have mounted over global pollution and large-scale environmental damage, the environmental angle has played a growing role, with energy shares increasingly finding themselves on the ESG blacklist.
But despite a sizeable basket of shares that are off limits, inflows into ESG themed exchange-traded funds (ETFs) are at record levels. According to data from Bloomberg, inflows in 2020 by late October had hit US$22 billion (A$30 billion). That's already 3 times the total inflows for 2019.
Not only is money pouring into ESG shares, companies that are seen to be doing the wrong thing are finding it increasingly difficult to secure financing.
Bank of America Corp (NYSE: BAC), under pressure from activist groups, had made it clear it won't be financing any oil and gas exploration projects in the Arctic.
As Bloomberg reports:
Bank of America has said it aims to position itself as a leader in environmental, social and governance matters in the financial industry through underwriting green bonds, reducing carbon emissions and supporting global climate initiatives. It has a goal of achieving net-zero emissions by 2050.
Aussie energy giant, Santos Ltd (ASX: STO), has no plans to drill in the Arctic. But the company is putting itself at the forefront of carbon reduction battle.
This morning Santos announced ambitious new emissions reduction targets.
Kevin Gallagher, Santos managing director, says the company is already on track to exceed its 2025 emission targets and will achieve net-zero emissions by 2040. Gallagher notes that, "The world still relies on hydrocarbon fuels for 80 per cent of its primary energy, the same as 45 years ago."
With that caveat in mind he adds:
Our focus over the last three years on step change technologies such as carbon capture and storage has enabled a pathway that allows us to go further faster when it comes to emissions reduction…
Carbon-neutral LNG cargoes are already in demand in Asia and customer countries such as China, Japan and Korea are aspiring to net-zero emissions around the middle of the century.
This will require increased use of natural gas to replace coal as well as new clean fuels such as hydrogen, already being used to reduce emissions from coal-fired power generation in Asia.
Our existing LNG customer base in Asia will be the hydrogen customers of the future, and as technology evolves and they transition to new clean fuels, Santos will transition with them.
Show me the money
Now many ESG investors remain motivated by the concept that they're doing the right thing. And they sleep better knowing that their money is invested in supposedly responsible shares.
(I say 'supposedly' here because there's the issue of greenwashing. That's where a company paints itself as far more responsible than it is. An issue that's exacerbated by the fact many ESG ratings still depend on a company's own sustainability reports. But that's a story for another day.)
But ever more investors are turning to ESG shares not to soothe their own conscience but to chase bigger gains. In fact, Nuveen's Fifth Annual Responsible Investing Survey, revealed that 53% of investors said they opted for responsible investments for better performance. That's the first time a majority of investors named performance as their main motivator in the survey's history.
Commenting on the results, Amy O'Brien, global head of responsible investing at Nuveen said, "Investors increasingly understand that promoting positive outcomes on important ESG issues, not only minimizes portfolio risks, it actually leads to improved performance overall."
Nuveen's survey results support the latest research from Mercer, a global leader in responsible investment advice and solutions, and a wholly owned subsidiary of Marsh & McLennan Companies (NYSE: MMC).
According to Mercer, the best sustainable investment strategies in Australian shares returned 10.4% annually over the last 3 years through to June 2020. Over that same time, the median actively managed Aussie equities fund returned 5.3%, while the S&P/ASX 300 (INDEXASX: XKO) returned 5.2%.
Paul Xiradis, Ausbil's chief investment officer, agrees that shares with a strong ESG focus can improve overall risk-adjusted returns. In a research report published by investment manager Ausbil yesterday, Paul said:
One positive thing that has come out of the pandemic is a sharper focus and demand for ESG and sustainable investment approaches. COVID-19 has accelerated changes in work-from-home, transport, travel, education and shopping behaviours that have significant implications and potential for sustainable approaches to investing, and the integration of ESG, as we do, across all investment strategies.
Sectors and companies with high proprietary ESG ratings based on Ausbil's extensive modelling, and demonstrating strong forward ESG momentum across any thematic, offer returns with a broader consideration of risks, improving overall risk-adjusted returns. This includes sectors such as technology, healthcare, renewable energy, electric vehicle and battery-linked metals, select leaders in consumer staples and consumer discretionary, high-quality industrials, and transition energy, amongst others.
This ASX share is riding the ESG growth trend
One ASX share that's captured the rapid growth in ESG investing is Australian Ethical Investment Limited (ASX: AEF).
Australian Ethical is an Australian wealth management company that invests according to its own strict ethical charter.
Despite getting smashed by the pandemic-fuelled market selloff earlier this year, with the share price plummeting 60%, Australian Ethical's share price is up 29% year-to-date.
The Motley Fool's own Scott Phillips recommended Australian Ethical to his members of Share Advisor on 24 October 2019.
Scott listed Australian Ethical's strong growth in funds under management, the fact that it had successfully launched into superannuation, and its highly scalable business as reasons to buy.
He also noted that he's previously questioned elements of ethical investing and is "largely neutral on the efficacy of the underlying idea". However, Scott wrote:
Whatever your thoughts are on the concept of 'ethical investing', there is no question that it is an increasingly popular trend; and with more than twenty years' experience, Australian Ethical is arguably the king of the hill.
The Australian Ethical share price is up 82% since Scott's recommendation. And in case you're wondering, Scott maintains a 'buy' rating on the shares.