When it comes to fund performance, the returns made by environmental, social and governance (ESG) funds might all just boil down to their co-incidental weightings to conventional investment styles, Vanguard argues in a new study.
In recent years, investors have shown greater and greater interest in doing good with their money and have increasingly been choosing to invest in funds that follow ESG philosophies.
Despite global economic uncertainty and geopolitical turbulence, this was still the case in 2022, when capital continued to flow into ESG-focused funds, as Trustnet reported.
But a recent analysis by Vanguard has suggested that the performance of ESG funds is driven more by more traditional investment style factors than by considerations around sustainability.
“The fact that many ESG funds persistently under- or overweight certain sectors offers a clue that they may have some systematic exposures to style factors,” read the report.
For example, the market capitalisation-weighted aggregate of US ESG equity index funds is overweight in technology and financials and underweight in stocks from the energy and industrials sector, as noted by Jan-Carl Plagge, Vanguard’s global head of active-passive portfolio research.
“If these sectors are linked to investment styles, it can reasonably be expected that sector deviations translate into style factor exposures,” he said.
On these grounds, Vanguard examined the gross returns of a selection of ESG equity funds over the course of the five years ending with 2021.
For all funds in the category, including both index and active funds, the research could identify an impact of the four style factors exposures that are generally known to have an influence on performance: size, value, profitability, and investment.
It was particularly highlighted, among other results, that both ESG passive and active funds tend to have a bias towards large-cap value stocks, which is bound to have had an impact on their performance before the value rotation of 2022.
Vanguard’s conclusion is that by over- or underweighting or altogether excluding specific companies or entire sectors from their portfolios, ESG funds take on an active risk.
“In some cases, these deviations can translate into systematic exposures to known style factors. These style tilts subsequently impact performance - both positively and negatively, depending on the direction of the exposure and the performance of the factor.”
Plagge invited ESG-conscious investors not to draw conclusions when it comes to ESG funds, but rather to “thoroughly investigate the constituents and philosophy of each individual fund they are considering”.a
“Otherwise, this could lead to unexpected—and unwelcome—results,” he said.