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Four reasons ESG investing continues to grow

Interest in ESG (Environmental, Societal, Corporate Governance) investing continues to grow at a rapid pace, and there are no signs to indicate that this investment trend will decelerate. Since 2012, global investment in ESG-centred products has more than doubled to almost $31 trillion, up from $13.3 trillion in a mere eight years.

In Australia, the growth has been even more convincing. According to 2020 research published by the Responsible Investment Association of Australasia, responsible investing currently accounts for 44% of the $2.25 trillion professionally managed investment universe, up from 17% from five years ago.

Further, Australian investors are among the most ESG-aware in the world, with 86% of Australians expecting their super or other investments to be responsibly and ethically invested. An even higher percentage (89%) want their investments to be invested with social and/or environmental factors in mind.

Whether or not this investor sentiment is in response to global events or events here at home – who could forget the fiery images of the 2020 bushfires – the message is clear. 

But for anyone holding back from investing in a product with a specific ESG investment tilt because they have heard it may be more expensive, or that it can’t achieve diversification, here are four pointers towards why this investment trend continues to grow in popularity.

#1 – Not too niche for a core portfolio

It is still a commonly-held perception that ESG products are too niche and should only be used in the satellite portion of your portfolio. However, the increasing popularity of ESG investing has resulted in new and differentiated products. There is now greater choice and availability of broadly diversified ESG products that could be used as the core of any investment portfolio.

Not all ESG products are created equal. Investors should understand the underlying ESG approach. If a managed fund or ETF utilises exclusions – weapons manufacturers, vice and fossil fuels for instance – investors should look at what portion of the broad market has been excluded, and determine if that is a suitable exposure for the core of their portfolio.

#2 – ESG investing returns are comparable to broad market returns

ESG products do not reflect the entirety of the broad market, which can be a result of the exclusions or screens applied to the investment. Investors should also be aware that returns could vary from the broad market, whether that be underperformance or outperformance. For instance, ESG-screened products typically outperformed the broader market during the first half of 2020, due to the minimal exposure to oil and gas markets which were particularly volatile during the initial stages of the pandemic. However there is no telling if oil and gas markets will bounce back or whether this trend of outperformance will continue for the long run. Based on Vanguard’s research, an investor can generally expect similar returns with an ESG product over the long term to that of the broad market.

#3 – ESG can be both active and index

Vanguard is known for its index funds and strategies but we believe that active and index strategies can work hand-in-glove to deliver a broader, well diversified portfolio. ESG investing is not limited to an active investing strategy. You can choose to be an active investor by seeking alpha with an ESG filter applied. Or you could choose to invest in an ESG index fund which provides a broader exposure and diversification, that still reflects your values and beliefs.

Both options should be viewed in the context of ultimately building a broadly diversified, low-cost portfolio, that takes a long-term view.

#4 – Bonds can be sustainable investments too

If ethical considerations are important when building a well-diversified investment portfolio, why would you stop at the equity sleeve of a portfolio?

Companies issue both bonds and equity. It would be inconsistent to exclude an equity based on ethical considerations only then to invest in the same company through their debt or bonds. Investing in a bond fund that reflects an investor’s values can be as simple as it is on the equity side, particularly as the number of ESG bond funds continue to grow.

Similar to ESG equity funds, ESG bond funds may screen out companies that engage in activities that are on an exclusion list and investors can achieve an entire portfolio that represents their ethical values.

Of course, whether ESG the core or a part of an overall portfolio, investing should always consider long-term goals, risk appetite and fees. The good news for investors who want their portfolio to reflect their values is, the more popular ESG becomes, the more choice that is available, leading to lower costs, investors feeling good and with the potential for strong performance.

 

Rachel White is Senior Manager, Product Strategy at Vanguard Australia, a sponsor of Firstlinks. This article is for general information and does not consider the circumstances of any individual.

For more articles and papers from Vanguard Investments Australia, please click here.

 

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