Quants Corner - ESG: Comparing organic apples to oranges

ESG: Comparing organic apples to oranges

A rising tide, they say, lifts all boats and the tide has been rising aggressively for EPFR-tracked Equity and Bond Funds with socially responsible (SRI) or environmental, social and governance (ESG) mandates so far this year.

The reasons for this influx of money range widely from the desire to do good to the desire to put as many layers of due diligence as possible between the buyer and their investment.

Because there are a multitude of not always compatible goals inherent in ESG mandates, and a wide range of indexes, standards and other yardsticks for measuring outcomes, extracting clear signals from the SRI/ESG universe of funds can be tricky.

In this blog we look at this trend through regional and country lenses to see what can be gleaned.

In 2020 an emerging theme

So far this year monthly flows to SRI/ESG Funds have been averaging around 2.2% of AUM versus less than 0.5% for all non-SRI/ESG Funds (a figure that would be even lower if Money Market Funds were not included).

Looked at on a regional basis, meanwhile, funds with US, Global and European mandates have recorded the biggest inflows in cash terms. 

But the absolute numbers obscure an important point: ESG status has been even more important for EM funds than it has for those dedicated to other regions.

Life raft in a redemption storm

Going into the second half of August, EPFR-tracked Emerging Equity Funds had posted outflows 25 of the past 26 weeks. But those with ESG mandates (see chart below) are still gathering assets – around 2.5% of AUM a month, on average, versus outflows of around 1% of AUM for non-SRI/ESG EM Equity Funds.

All these funds pouring willy-nilly into EM ESG funds has resulted in their share of overall EM assets under management growing steadily over the course of 2020.

Russian exceptionalism

At the country level, however, building models or strategies based on the broad trend can run into trouble. Russia is a case in point.

When it comes to Russia, money has been pouring out of SRI/ESG Russia Equity Funds while non-ESG funds have been less affected (see chart below). These redemptions are not performance driven. The performance of Russia ESG funds hasn’t been much different from that of Russia funds in general.

This has resulted in the assets under management of Russia ESG funds, as a percentage of those of all Russia funds, decreasing over the course of 2020 from 16.5% of the total to 15%.

The fact that 15% of all assets held by Russia Equity Funds are held by just 10% of that fund universe is still striking. It reflects the premium investors place on governance in the Russian markets, and the outflows are in some ways a back-handed compliment to the relative liquidity of the SRI/ESG Funds.

So where does this lead us?

As we have seen investor demand for ESG funds across all asset classes is running hot, particularly when it comes to emerging markets, and we anticipate this continuing for the rest of the year. That said, not every emerging market has seen the flood of ESG money. Russia remains a notable exception.

For quantitative modeling, several key questions remain. Does the consistency of flows into ESG funds, particularly those in EM, sufficiently compensate for the themes fragmented nature and inherent contradictions? Is the consistency we are seeing now a harbinger of future flows?

The answers, alas, will have to wait for another blog.

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