Investors’ Interest In Sustainable Funds Continues to Grow

Stig Zarle
Vice President, Portfolio Manager

August 17, 2020

Investing & Economy

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The wave of assets flowing into sustainable investment funds in the US continued to show strong momentum in the first half of 2020 despite the persistence of the COVID-19 pandemic. The renewed social, environmental, and civic awareness stemming from both the pandemic and the increasing social unrest across the country has fueled interest in sustainable investing. As investors committed record amounts of new capital to funds in the first half (spanning equity, fixed income, life-cycle, and alternative mandates) with a stated focus on ESG/impact/sustainability, broader market flows have sputtered under the weight of the pandemic’s disruption on financial markets, especially in the first quarter. Flows into sustainable funds in the first six months reached $20.9B according to Morningstar—more than double the amount taken during the first half of 2019. While strong performance has contributed to the rapidly growing investor interest in sustainable investing, COVID-19 has placed a spotlight on companies and their ability to manage unforeseen risks (such as a quick-forming pandemic) all while protecting the interests of their customers, employees, partners (suppliers and communities) and the environment. Investors are increasingly seeking exposure to these attributes in their portfolios. Investments in these long-term focused, well-managed companies are the rule, rather than the exception, in sustainable investing.
As COVID-19 froze the global economy in the first quarter, US fund outflows exceeded $250B (see Exhibit 1). Investors pulled back on their investments in both equities and bonds alike, especially in the month of March when negative flows of $373B hit according to the Investment Company Institute. Broadly, flows have turned around in the last three months largely due to strong demand for fixed income fund offerings. Sustainable funds, however, have bucked the trend of the broader fund/ETF complex and registered 19 consecutive quarters of positive new flows as detailed in research provided by Morningstar. In Q2, strong flows in both equities and bonds resulted in $10.4B in new investment dollars flowing into sustainable funds (see Exhibit 2); year-to-date, the inflows of $20.9B into sustainable investment vehicles compares to net outflows of $160B across the entire US mutual fund and ETF complex.

Exhibit 1: Aggregate Fund Flows

Exhibit 2: Sustainable Fund Flows

So, what is behind the acceleration of new assets into sustainable funds in the US? To be clear, the big step up in sustainable fund flows occurred in early 2019, but the marked acceleration began to take hold in the fourth quarter of that year. Part of the explanation comes from the increase in supply of ESG-focused funds; Morningstar noted that there were nearly 500 funds that listed ESG as a consideration in their investment process last year, an increase from under 100 in 2018. Performance, too, has helped attract assets to sustainable funds. The MSCI KLD 400 Social Index, for example, has outperformed the S&P 500 in 2018, 2019, and 2020 year-to-date, based on data provided by Bloomberg.
COVID-19, with its myriad challenges, has also contributed to the accelerating growth of capital flows into sustainable funds. The pandemic has laid bare companies that were either short-term focused or ill-equipped to deal with crisis. As a result, those companies have typically underperformed the market as they scrambled to mitigate the pandemic’s impact by attempting to cut costs for immediate benefit at the expense of long-term growth and viability. Companies that focus on sustainability and durable, long-tailed growth, however, planned for scenarios like COVID-19 years earlier. As a result, they were prepared to safeguard the most crucial aspects of their business; their customers, their employees, and their suppliers, and, therefore, their reputation—during the crisis. Investors are taking notice. As interest in sustainable investing grows, investments in forward-thinking companies that prioritize long-term vision over short-term gain will play a central role in attracting new assets to the space.