Analysis: The bear market puts ESG investing to its first big test

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July 13 (Reuters) – Investing based on environmental, social and corporate governance (ESG) principles has become a $35 trillion industry following a long stock run that lasted from 2009 until early this year.

Investors now have to decide if they’re going to stick with it when making money isn’t easy anymore.

The onset of a bear market this year, driven by rising interest rates and worries about a possible recession, is testing investors’ ESG commitments. U.S. sustainable funds saw a rare monthly outflow of $3.5 billion in May, according to Morningstar (MORN.O). Read more

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Even before that, inflows into these funds had slowed. They took in $7.5 billion in the first five months of this year, down from $35 billion in the prior period.

Still, Alyssa Stankiewicz, associate director of sustainability research at Morningstar, said ESG fund outflows would need to be supported for weak demand to be more than a “hiccup”.

“If we were to try to claim that demand for ESG funds is deteriorating significantly, you would want to see demand declining faster and for an extended period of time than the broader market,” Stankiewicz said.

ESG equity funds have faced headwinds in their portfolios on two fronts this year. Tech stocks, which ESG funds tend to be overweight because they are perceived to be more environmentally friendly, underperformed the broader market. And oil and gas stocks, which many ESG funds are underweight due to concerns about climate change, outperformed on the back of rising energy prices following Russia’s invasion of Ukraine. Read more

While US sustainable funds outperformed a cross section of other funds by 1.4% annually in the five years to June 30, they underperformed the broader market by nearly 2% over the first half of 2022, according to Morningstar Direct (MORN.O).

Surveys of investors, seeking to gauge their future response to the recession, have been mixed.

A survey published by the Journal of Financial Planning and the Financial Planning Association last month found that 28% of financial advisors plan to increase their use or recommendation of ESG funds over the next year, up from 24% in 2021. But it also found that 15% planned to reduce their use over the same period, compared to just 4% in 2021.

An RBC Wealth Management survey of 976 U.S.-based investors released in April found nearly half said financial performance and returns were a higher priority than ESG impact, compared to 42% who said so last year.

Peter Essele, head of portfolio management for investment adviser Commonwealth Financial Network, said ESG investors tend to have long investment horizons which makes them “sticky” to the asset class.

“They tend to be less performance-oriented than your traditional investor, so I think there’s a willingness to engage and stay with companies during volatile times,” Essele said.

That view is shared by many on Wall Street, including investment bank Morgan Stanley, whose equity analysts said last month that “softening ESG sentiment” did not represent a “structural slowdown.”

POSITIONING FOR A CLIMB

Tim Hughes, managing director of investment adviser Wealthspire Advisors, said he has seen client interest in ESG investing increase over the past year. “We’ve seen some underperformance, but I feel like it’s expected, and expectations have been managed as such. Frankly, I haven’t gotten a lot of pushback (from customers)” , did he declare.

Market trends may favor ESG fund portfolios in the coming months. Tech stocks, for example, have staged a small rally since last month that would boost ESG funds if they gain momentum.

Cheryl Smith, economist and portfolio manager at ESG investor Trillium Asset Management, said periods of slow economic growth often favor companies with stable growth prospects, including those in friendly tech and healthcare sectors. of the ESG.

Amber Fairbanks, portfolio manager at sustainable investment firm Mirova US, said she doesn’t invest in ESG just “to feel good” and sees opportunities in this environment for returns. superior to the overall market.

“We see it as a source of outperformance, and that’s something I think more and more investors are starting to recognize,” Fairbanks said.

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Reporting by Cole Horton in New York and Ross Kerber in Boston Editing by Greg Roumeliotis and Nick Zieminski

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