Evidence of ESG's impact "inconclusive": Morningstar

The evidence that global equity ESG funds can improve returns or reduce risk on average is "inconclusive," according to Morningstar.

Fund flows into sustainable investments is growing strongly. According to research from Rainmaker Information, a net total of $1.9 billion have gone into ESG related unit trusts in the twelve months to the end of June 2021, while a further $1.8 billion have gone into ETPs at the same time.

Morningstar's research reinforces this data. According to Morningstar's Sustainable Investing Landscape for Australian Fund Investors report for Q2 2021, assets in Australian sustainable investments were $33.42 billion on 30 June 2021, a 66% increase from a year earlier.

However, determining how ESG strategies impact on risk and return is a more complex challenge. Morningstar identified 33 Australian-domiciled large-cap global equity funds that are tagged as sustainable investment funds. Nineteen of the 33 funds have a three-year track record, while just 14 of the 33 funds have a five-year track record as of 31 August 2021, Morningstar said.

"This empirical evidence shows not a single one of the 14 ESG global equity funds available to Australian investors five years ago has been able to deliver a higher return with lower risk than the broad market index," Morningstar said. "Five funds (plus the Morningstar Global Markets Sustainability NR Index) have delivered lower return with lower risk over this period, five funds have achieved higher returns with higher risk, while four funds have delivered the double-whammy outcome of lower returns with higher risk than the index."

"What that is suggesting is that from an overall risk performance perspective, ESG funds aren't materially different on average to the benchmark," said Morningstar director of manager research, Asia-Pacific, Tim Murphy. "But within that, if you are selecting funds like that, you're still achieving the values alignment without sacrificing risk and return outcomes.

"From a pure performance or investment outcome perspective, there's no difference, but you're not giving up anything by seeking a portfolio that aligns with your values."

Meanwhile, Rainmaker Information has analysed Australian equities ESG products for style bias and found that these products "are more biased towards 'quality' companies than to an official ESG index. In international equities, ESG products are more likely to be biased to an ESG index. In both cases the products were heavily underweight to the value style, the research found.

Value investing has underperformed growth and quality in the five years to June 2021 but has outperformed by a significant amount more recently. There could be future performance risks to ESG products, given their bias to quality, "if value continues its rebound and predominates over growth and momentum styles," the research said.

"ESG people need to stop drinking the Kool-Aid," said Rainmaker Information executive director of research and compliance Alex Dunnin. "They've had a period of outperformance over regular products but that's passed, at least for now. They should also remember that their job is not to outperform, it's to not underperform. And no one should ever use ESG as an excuse for underperformance."

Read more: MorningstarRainmaker InformationAlex DunninTim Murphy