If there’s any silver lining to come out of the COVID-19 pandemic, it’s that an increasing number of investors are thinking more carefully about the impact their holdings are having on the world.
In 2020, inflows into Canadian-based environmental, social and governance (ESG) funds topped $3.2 billion, while total net assets in ESG funds topped $22 billion, a 37% increase over the year before. The company also found that 12.3% of global asset managers have put a greater importance on ESG considerations since the pandemic began.
While interest in ESG investing was on the rise before the COVID-19 pandemic, people are paying even more attention to everything from climate change to the treatment of employees to pressing social causes. Combined with a push from CEOs of major corporations to identify ESG risks within their own businesses, and with more regulations – in Europe, but soon elsewhere – around sustainable finance-related disclosure requirements, interest in ESG will likely continue well into the future, says Priti Shokeen, head of ESG Research and Engagement at TD Asset Management Inc.(TDAM).
“There’s an ever-growing awareness about systemic risks that we are facing as a society such as our rapidly changing climate and social inequalities, and an unwillingness to keep the status quo, whether that’s through our personal values or through our investments.” she says. “The industry also reached an inflection point over the last two- three years with maturing ESG strategies and funds showing that ESG does not take away from investment performance. The COVID-19 pandemic was the first true test of that and ESG showed potential for downside protection.”
Currently, assets under management (AUM) in Canadian-listed ESG-focused funds account for less than 1% of AUM in all Canadian funds – $22 billion compared to about $2 trillion, according to ISS – but that number could see a dramatic increase over the next several years.
For one thing, the market continues to evolve from its traditional do-no-harm focus, which mainly involved companies taking action against issues that could hurt their business, to one that’s more purpose focused, where doing something good – for communities, customers and the planet at large – drives business decisions.
With more people wanting to understand how companies they are investing in, are being responsible – that may be reducing their carbon footprint or offering staff at least minimum wage – businesses will need to be more transparent about their ESG risks, says Shokeen.
“Companies will be disclosing ESG risks more systematically, and that information will help people make better investment decisions,” she says.
It also helps that millennials are more ESG minded. Morgan Stanley found that while the interest in sustainable investing among all investors climbed to 85% in 2019 from 71% in 2015, it jumped to 95% in 2019 from 84% in 2015 among millennials. That’s important because this generation will inherit billions of dollars from their boomer parents over the next decade.
Given their interest in ESG, much of that money will go into ESG-related funds and to the advisors who embrace sustainable investing.
“There is a greater willingness among millennials and increasingly among high net worth investors to act through their spending and investing,” notes Shokeen. “Advisors need to educate themselves so they can talk knowledgeably about these products, especially given the proliferation of ESG.”
More options for investors
As interest in ESG increases, so too will the kinds of products investors can buy. While a number of ESG-focused mutual funds have been created over the years, the ESG ETF market is one area that many investors and advisors are now focused on. ETFs by their nature are low-cost, highly liquid and easy to buy, which is ideal for someone who wants to build any portfolio, but especially one that has a particular focus.
Over the last few years, a number of ESG ETFs have come to market globally with different approaches – some focus on gender parity among executives or technologies that advance renewable energy, others simply remove fossil fuels from existing funds. TDAM, which has long been implementing ESG practices into its various mutual funds, has recently launched three ETFs that incorporate a variety of ESG approaches into one investment vehicle.
The three funds – TD Morningstar ESG Canada Equity Index ETF (TMEC), TD Morningstar ESG U.S. Equity Index ETF (TMEU) and TD Morningstar ESG International Equity Index ETF (TMEI) – give investors exposure to companies with high ESG ratings across a broad number of factors, including alignment of management compensation with shareholder returns, health and safety issues, environmental impact and more. The funds, which follow indexes designed by Morningstar, using ESG ratings provided by Sustainalytics, a Morningstar Company, also stay away from tobacco, weapons and gambling operations, as well as those companies that have been embroiled in controversies, such as bribery, corruption and human rights violations.
“With these ETFs, investors can access best-in-class ESG companies and also closely track the broad parent index,” she says. "The main idea is to provide a low-cost solution, that provides market-like return while having positive ESG exposure and aligns with your values"
As more companies take ESG into account, and as a greater number of investors seek out more responsible products, there may come a point when ESG will be fully integrated into investing mindset, however, says Shokeen, “the levels of integration within companies, and investment process will provide room for differentiated ESG investment strategies.”
Until then, Shokeen thinks that over the next five to 10 years, ESG related disclosures will remain a focus and we'll see an increasing push towards standardization, while responsible investing will go even more mainstream.
“At a simple level, this is common sense,” she says. “Companies that negatively impact their environment or people will get penalized, while the ones who take it seriously will get more attention from investors.”
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1 SIMFUND Canada, ©Institutional Shareholder Services Canada Inc. (Investor Economics, A Division of ISS Market Intelligence) 2021. All rights reserved.
2 Morgan Stanley. Sustainable Signals: Individual Investor Interest Driven by Impact, Conviction and Choice