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How to navigate the ESG maze

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  • Both UK and Global ESG funds have underperformed over the last year
  • But regulation will drive further ESG flows
  • Top ten holdings of UK and Global ESG funds
  • How to navigate the ESG maze

By Laith Khalaf, head of investment analysis at AJ Bell, comments:

“The performance tide has turned against ESG funds of late, as growth stocks have floundered, and oil and gas companies have profited from rising energy prices. That won’t stop money flowing into responsible investments though. There is genuine consumer demand for these products, and the investment industry has sunk a lot of marketing dollars into launching new funds and rebranding existing ones which now carry the ESG tag. On top of which, longer term performance of ESG funds compares favourably to more traditional offerings, especially in the global fund sector.”

Total return %
1 year 3 year 5 year
IA Global funds
ESG 6.6 43.4 66.4
Non ESG 8.7 40.0 60.6
IA UK All Companies funds
ESG 2.2 14.8 25.3
Non ESG 5.9 15.3 25.9

Sources: AJ Bell, Morningstar to 5th April 2022

Regulation will drive further ESG flows

“We’re still in the foothills of ESG investing, and consequently the infrastructure to support investors is still being somewhat hastily erected. The FCA will be consulting on introducing a green labelling regime in the next couple of months, which should add some much needed clarity to what investors can expect the extensive ESG vocabulary to mean in practice. Greater disclosure requirements could well drive further flows into responsible investment funds. Data compiled by Morningstar shows that 42% of European fund assets now sit in ESG funds, even though the EU’s regulatory classification scheme was only introduced in March 2021 (what are known as SFDR Article 8 and 9 funds).

“The widescale adoption of regulated ESG classifications in Europe suggests that the endgame is likely to see the majority of funds incorporating some kind of ethical framework into their investment process, especially those offered by large investment houses. Rules governing how advisers integrate their clients’ ESG preferences are also heading down the track, which will encourage asset managers to add a responsible investment lens to even more funds.”

What does an ESG portfolio look like?

“Investors looking to put money into ethical funds, or indeed those looking for individual stock ideas, might well be interested in the most popular holdings within ESG funds. Within global funds, the top ten most popular holdings have a distinctly technological flavour. That is perhaps unsurprising given the extent to which technology stocks feature in the world index at large, but also underlines these companies do tend to score well on ESG factors too. That’s despite the fact that some of them face questions around anti-competitive behaviour and the levels of tax paid in certain jurisdictions.”

“What’s most notable about the most popular holdings in UK ESG funds is the number of financial services firms in the top ten. This sector tends to score well on ESG metrics, as it isn’t a heavy industry that needs to consume lots of carbon to conduct its daily activities. However, the inclusion of Lloyds might raise an eyebrow or two, seeing as the bank is still mopping up after past misdemeanours, and had to set aside £1.3 billion in the last financial year for customer remediation. Pharma stocks are also a bit of a shoo-in for UK ESG funds their core business results in better health outcomes for society at large.”

10 most widely held shares in global ESG funds 

Microsoft Corp Technology
Alphabet Inc Class A Communication Services
Thermo Fisher Scientific Inc Healthcare
Schneider Electric SE Industrials
Apple Inc Technology
Mastercard Inc Class A Financial Services
Amazon.com Inc Consumer Cyclical
Novo Nordisk A/S Class B Healthcare
ASML Holding NV Technology
Taiwan Semiconductor Manufacturing Co Ltd Technology

Sources: AJ Bell, Morningstar

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