Universe of ESG-Focused Funds Growing, Seeing Record Flows

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. We recently released the Sustainable Fund Landscape Report. I'm here with its author, Jon Hale, he is our director of sustainable investing research, to go over some of the big key takeaways.

Jon, thanks for joining me.

Jon Hale: Good to be here.

Glaser: Your first takeaway was that the universe of sustainable funds, of ESG-focused funds, really continues to expand at a rapid clip.

Hale: Yeah. In fact, this year we had 351 open-end and ETFs in the study; last year only 235. So, quite an increase in just one year.

Glaser: You second point is really around flows. Are people interested in these funds? Are they just launching or are they actually attracting investments?

Hale: It was very interesting. This year, despite market headwinds that actually produced a bad year for net flows for most long-term funds in the U.S., for the third year in a row sustainable funds had record flows, about $5.5 billion into this group of funds that we label as sustainable, the third year in a row, as I said, that was a record.

Just to put it into context, I went back for the 10 years following the financial crisis--the first four years of that, so that'd be 2009 to 2012, the average inflow per year for these funds was about $135 million--very, very small, tiny. Now, for the past six years the average flow has been about $4.5 billion and $5.5 billion just in the last year. So, still not huge compared obviously to the overall fund universe, but an immense amount of growth during this decade.

Glaser: The third point is around active/passive, always a hot topic. ETFs are taking a bigger share here. Why are those starting to catch on in this world?

Hale: We've seen a lot of issuance of new ETFs in the past three years. It is now possible for sustainable investors to develop a market-based portfolio using ETFs or other passive instruments that are open-end as well. I think it's something that clearly follows the trend toward ETFs. ETF providers think this is an area where flows will materialize, and they have started to do that just in the last year.

Glaser: As this universe begins to expand are you seeing a breakdown of where funds are landing in terms of the strategy that they are using to kind of hit these ESG factors? What's that looking like?

Hale: All ESG/sustainable funds are not alike. I identify in the report four different types, actually, of funds that you can tell based on both their holdings, how they do in the Morningstar Sustainability Rating, but also just what they say in their prospectus. There's a lot of funds out there previously launched, open-end funds that have added ESG to their prospectus indicating to me that they are now considering ESG as a part of their process which otherwise remains unchanged. We will have a lot of those kinds of funds now. The sort of more standard approach to ESG, I call ESG integration, which are funds that really try to use ESG in a more comprehensive and holistic way than the consideration funds, and they also do a lot of active ownership engaging with companies that they own.

Then thirdly, there's impact funds. That's a new trend as well. Funds that in addition to wanting to deliver financial return, they want to deliver some sort of discernible measurable impact, societal impact, environmental impact to their investors, and they are calling themselves impact funds and they are really focusing on how they convey that idea to their investors.

Then, finally, funds that have been around for a long time, sustainable sector funds, I call them, are focused really on those areas of the economy and those companies that are involved in the transition to a low-carbon green economy.

Glaser: Finally, what has performance looked like?

Hale: Performance was good last year, very good. In fact, if you look at on average funds in the universe, half the funds would finish in the top half of their Morningstar Category. Sustainable funds, which can be found now in dozens of different Morningstar Categories, 63% of sustainable funds finished in the top half of their Morningstar Categories last year. Only 18% finished in the bottom quartile. So, very good performance last year really across the board. All these different types of funds did pretty well. Equity funds did especially well. They tended to hold up well during the difficult market environment.

Glaser: Jon, thank you.

Hale: My pleasure.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.