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ESG vs non ESG portfolios: investors should look up before reaching the point of no return

In “Don’t Look Up”, the latest blockbuster from Netflix, two astronomers discover a planet-killing comet hurtling toward Earth. As vital as it is, Di Caprio’s and Lawrence’s warning is met with a very unimpressed and hedonistic audience who merely discards the umpteenth call for the end of the world. No spoiler, but it did not end well… Good news is you will not read about a threatening asteroid in this article, but climate change is no less worrying. Sustainable finance has set up a new era where extra financial aspects matter just as much as growth prospects, and this is another good news. However, much remains to be done to back up words with action if we want to avoid the “point of no return” - in both senses of the word.

COP26 came short of expectations, to say the least, but it is worth mentioning that a growing number of investors are venturing into ESG investing. In 2021, Morningstar reported that global sustainable funds attracted record inflows of $4 trillion  in 2021. This shows ESG is more than a fad and rather a new mindset that all money managers should embrace for the best interest of the planet, but also for their own interest. Based on year-to-date returns as of mid-December 2021, 56% of sustainable funds ranked in the top half of their respective Morningstar Categories, and only 44% ranked in the bottom half. The dichotomy between ESG and non-ESG is far more striking if we step back and compare historical performance of MSCI World vs MSCI ESG Leaders index. Indeed, the price performance of the virtuous stocks was higher than its “old economy” peers for seven out of the last ten years. However, the rally in ESG shares has also lifted their valuations overall, making them more expensive. The MSCI ESG Leader index's forward 12M P/E is on average 1.3 points higher at 20.5 vs 19.2.

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Figure 1 : Price performance MSCI World (left) vs MSCI ESDG Leaders index (right)

Generally speaking, over the last three years, the main ESG global equity indexes continue to outperform their non-EGS peers. For instance, the MSCI World ESG Leaders index (white) has outperformed the traditional MSCI World index (dotted orange) by 278 bps.

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Figure 2 : Equity - ESG vs Non-ESG Indexes.

As far as fixed income is concerned, we can reiterate our observation made three months ago, the relationship is blurrier over  the same timeframe. Indeed, the performance of non-ESG corporate bonds is pretty much in line with that of their non-ESG equivalent if we compare the Bloomberg Barclays Green Bond Index (dotted orange +10.18%) and the Bloomberg Barclays MSCI Global Aggregate ESG (white +9.22%) to the standard Bloomberg Barclays Global Aggregate (dotted yellow +10.08%). However, we can say “advantage green” if we consider another benchmark, because the JP Morgan ESG EMBI Global Diversified index (red) outperforms its non-ESG homonym (dotted green) by 75 bps. Let us recall, however that performance showed can differ dramatically depending on the reference date and the benchmark selected (Source: Bloomberg Finance L.P., 13/01/2022). 

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Figure 3 : Bond - ESG vs Non-ESG Indexes.

With a view to assessing and fostering clients’ commitment to sustainable investing, FARAD Investment Management has developed an internal proprietary ESG scoring system, called GreenEthica Sustainable Scoring System (GSSS). This report aims to provide a reliable and objective way to assess the main ESG portfolio metrics with a comprehensive focus on its alignment to the 17 Sustainable Development Goals (“SDGs”). Thanks to GSSS, FARAD IM can produce a synthetic sustainability report with selected key ESG metrics to unveil the real sustainability profile of a portfolio and to compare it in relative terms with a benchmark. Thanks to this easy-to-read ESG dashboard, investors can visualise their quantified contribution to the achievement of the 2030 Agenda for Sustainable Investments of the United Nations.

Mathias Talmant
Junior Portfolio Manager
FARAD Investment Management S.A.

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