ESG vs non ESG portfolios:
Post pandemic infra plans should benefit the green transition

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The ESG gold rush has never been more real with 330 new funds launched year to date and a three fold increase in the number of companies net-zero targets. Investors shifted from a myopic profit maximization focus to a more sustainable model where capital appreciation matters as much as environmental and social considerations. This trend confirms the need for SFDR to dissociate change-makers from marketing specialists.

Every cloud has a silver lining; after a Trump mandate of backpedaling on climate actions, the new US President gives centerstage to “E” discussions. Biden’s multi-trillion Keynesian plan will reinvigorate climate urgency in the US and be a boon to wind, solar and other renewable energy companies. After rejoining the Paris agreement on climate change, the new leader of the second biggest polluter pledged to decarbonize the U.S. power sector by 2035. These moves come alongside stark evidence of the economic costs of climate change. According to the National Oceanic and Atmospheric Administration, the U.S. broke an unsettling record, 22 extreme weather and climate change-linked disasters in 2020, which caused collectively $95 billion in damages and killed 262 people. The conclusion is clear, investing in the green revolution is not only a trendy investment theme, it is also a question of life or death. The announcement of the infrastructure plan seems to be partially priced by the market as the ECPI Global ESG Infrastructure Index beat the S&P Global Infrastructure Index by 202 bps over the last three months.

 

Figure 1: Infrastructure - ESG Portfolios vs Non-ESG Portfolios

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Source : Bloomberg Finance L.P.

Generally speaking, empirical evidence demonstrates that over the last three years, the main ESG global equities indexes have outperformed their non-EGS counterparts. For instance, the MSCI World ESG Leaders index has outperformed the traditional MSCI World by 305 bps. Contrary to what we saw in our latest article released three months ago, the relationship is not so clear anymore when considering fixed income over the same timeframe. Indeed, the Bloomberg Barclays MSCI Global Aggregate ESG lags very slightly by 57 bps compared to its non-ESG equivalent whereas the JP Morgan ESG EMBI Global Diversified index outperforms its non-ESG homonym by 126 bps. A possible reason is that ESG fixed income strategies tend to include more growth firms’ corporate bonds, which have underperformed value firm’s this year as a result of inflation rise concerns (Source: Bloomberg Finance L.P., 06/30/2021).

Investors should remain wary of greenwashing and conduct a thorough due diligence because marketing materials may not translate into explicit investment rationales. In this context, SFDR (“Sustainable Finance Disclosure Regulation”) was enforced in March 2021, supporting fund selectors with a precise classification of ESG strategies. Several funds that previously claimed to follow ESG criteria are actually classifying themselves as “Art. 6” (i.e. mainstream funds with no explicit sustainability scope), and others have been required to change the fund name itself to remove all references to "sustainability". On the other hand, the number of funds that declare themselves as “Art. 9” (i.e fund with an explicit sustainable investment objective) is still relatively limited. Nevertheless, “Art. 9” seem in outperforming significantly their relative not-sustainable competitors. In the graph below and for illustration purposes, three ESG funds (“Article 9”) exhibit greater performance than non-ESG equity strategies in their respective categories/geographic areas since the enforcement of SFDR in March 2021.

Figure 2: Art. 9 funds vs non-ESG Portfolios

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Source : Bloomberg Finance L.P.

 

Enforcement SFDR

Non-ESG

In this context, FARAD Investment Management has developed an internal proprietary ESG scoring system, called GreenEthica Sustainable Scoring System. It is based on a large data-set of ESG criteria and factors, with a specific screening on investments which are aligned to the 17 SDGs (UN Sustainable Development Goals). This service provides a reliable and objective way for investors to see how mutual funds, ETFs, equities and/ or bonds are meeting environmental, social, and corporate governance challenges, and it provides the investor also the measurable figures of how much its investment is contributing to the sustainable transition and to the achievement of the 2030 Agenda for Sustainable Investments of the United Nations.

 

Gianluca D’Alessio

Senior Portfolio Manager

FARAD Investment Management S.A.