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The truth behind the ESG backlash

By: Toby Finden-Crofts


We are all feeling the recent rise in energy prices in the UK, either in our household bills, the purchases we make, the services we use or all of the above… and indeed for those with higher fossil fuel inclusions in investment portfolios, stronger performance in portfolios year-to-date.

And it is the latter that is part of the backlash against ESG investing we have seen recently from some corners of the intermediary market. However, this backlash has also occurred due to several other reasons, and so the explanation is somewhat intertwined among a multitude of driving factors.

Here is some form of explanation:

1. The transition on renewable energy was put on the backburner when Russia invaded Ukraine, causing a shortage in energy supplies and a spike in prices. In order to meet demand, focus was placed on fossil fuels. Performance in oil and gas stocks soared, leaving the sectors that are considered to have higher ESG credentials well behind.

2. In the US, ESG has been singled out for “wokeness” and some states, including Texas and West Virginia, are seeking bans on investing through fund managers into any products that exclude oil and gas holdings.

3. Regulatory action against companies for greenwashing has not helped the cause. Last year Deutsche Bank’s asset manager DWS Group hit back at claims it overstated the amount of assets that comply with sustainability criteria amid news of probes by US and German authorities into the allegations.

4. There have also been some high-profile individuals working as senior responsible investment professionals that have hit the headlines for controversial claims. Former head of sustainable investing at BlackRock Tariq Fancy called ESG a “dangerous placebo that harms the public interest” as he said some groups were simply using it to product push, while HSBC Asset Management suspended its global head of responsible investing Stuart Kirk (who later resigned) after he dismissed climate change concerns as “unsubstantiated” and “shrill” in a presentation.

Amid all this, is the bottom line – ESG performance year-to-date has been below the market average, further exacerbating some perceptions that ESG could be just a fad.

Indeed, our research shows discretionary fund managers and advisers have some concerns. When asked about barriers to responsible investment, DFMs highlight concerns that some responsible investments are potentially overvalued. While both DFMs and advisers mentioned it could hinder investment performance as a top five concern.

Jack Dominy, research manager at Research in Finance, commented: “We have certainly seen a dampening of appeal towards some ESG funds and sustainable investing more broadly in recent research, driven by current market conditions. It goes without saying that all intermediaries are ultimately driven by performance, regardless of their strength of alignment to certain values, and funds which include oil, gas and defence companies have tended to outperform recently. Yet there are intermediaries who are also pragmatic about the very nature of investing when performance of ESG funds is discussed; the long term outweighs the short term, and so investors should keep this is mind when assessing portfolios.”

As is reiterated often in the investment industry, we are on a journey and sustainable investment professionals have tried to educate clients about a simple fact – without sustainable investment, and the direct allocation of capital to companies and projects that mitigate climate change and protect the environment and biodiversity, we will not have planet Earth in years to come.

The positive news is that a large number of investors get this. Amid a swirl of cash exiting markets in the second quarter, assets in sustainable products fared much better; global sustainable funds saw inflows of $32.6bn in Q2 this year – a decline on the first quarter, but stronger than the broader market which saw outflows of $289bn, according to a Morningstar update.

Commenting on the report, Hortense Bioy, global director of sustainability research at Morningstar, said: “Amid investor concerns over a global recession, inflationary pressures, rising interest rates, and the conflict in Ukraine, sustainable funds net inflows plummeted in the second quarter, but fared better than the broader market. Sustainable funds are essentially stickier.”

Furthermore, product development continued apace with fund groups continuing to bring high numbers of new sustainable funds to market or repurpose existing strategies, and although assets under management in sustainable funds dipped by 13.3%, the broader market declined more by 14.6%.

This is encouraging and as more investors wake up to the damaging effects of climate change, now felt in our every day lives with heatwaves and drought across the world, there will likely be more capital directed towards renewable energy sources and technology that will play a positive part in the climate crisis.

To jump on the performance bandwagon seen in fossil fuels recently is short-termist and the companies that do not address this in their own business models will not be around in years to come.

Further reading:

Morningstar Q2 flows update: Global_ESG_Q2_2022_Flow_Report_FINAL.pdf (contentstack.io)

*The UK Responsible Investing Study (UKRIS) quantitative research surveyed 215 retail intermediaries, providing a wealth of information in responsible investing. The latest findings are taken from Wave 3 of this annual study conducted by Research in Finance. The study included feedback from a mix of DFMs (110) and IAs (105), and fieldwork was conducted in December 2021 to January 2022.

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