ESG funds may suffer as tech stocks fall

ESG-focused funds face an uncertain outlook as managers’ research costs and equity impacts grow.

Inflows exploded during 2021, with assets in sustainable global funds doubling between April and September, when they reached $3.9 trillion, according to data from consultancy Morningstar.

In December, the main shares of the 20 largest ESG funds, which together manage US$ 340 billion (R$ 1.86 trillion) in assets, were from tech giants Microsoft, Alphabet (which owns Google) and Apple, according to Rumi Mahmood, vice president -president of ESG Research at MSCI.

But tech stocks have been taking a hit this year. This move fuels speculation that a more sustained turn towards value strategies is looming as the Fed begins to pull back on Covid-19-era stimulus.

“It’s going to be an important test for the industry. I’m not convinced that 100% of those who are buying sustainable funds are doing so purely for environmental and ethical reasons. Many are at it as ‘tourists’ because these were simply the best performing funds. “, said David McCann, equity analyst at Numis.

The Nasdaq Composit, an index focused on technology companies, had its worst start to the year in half a decade. It may be an isolated point, but a sustained shift in the market could be painful for ESG funds.

“Certain names are at the top: Microsoft, the rest of the big techs, big health plans… These stocks are trading higher, but if we turn around and rates go up, they’ll all be beaten. Banks and funds may do better, and those are often undervalued in ESG funds,” said Tom Mills, equity research analyst at Jefferies.

The shares of some more ESG-focused companies have been falling since the beginning of the year. The share price of London-based Impax has dropped 15% since early January, and Liontrust is down by about 14%.

Top 20 ESG funds’ top stocks are technology and healthcare

ESG fund managers say that sustainability has now become so tied to investment strategies in general that a significant reversal is unlikely. For many investors, certain energy and resource companies are no longer “investable,” no matter how well their stock performs.

And while interest rate hikes dampen future returns on tech companies, the investing public for some of those companies has also exploded.

“We’ve increasingly seen the market accept the idea that companies need to set net zero targets and therefore need to buy clean energy,” said Amanda O’Toole, who runs a cleantech themed fund at Axa Investment Managers.

Much attention has been paid to the ability of cutting-edge technology to address sustainability issues. But fund managers are also looking for possibilities among more traditional companies.

“There are new entrants to the climate and ESG fund management business. Let’s find out, as well as between companies, who is good at what they do,” said Simon Webber, fund manager at Schroders.
He believes companies like construction company Kingfisher, insurance company Munich Re and carmaker BMW will be big winners in the climate transition.

Sustainable investments are also subject to rising research costs, which are expected to reach US$1.3 billion globally in 2022, straining the already thin margins of investment houses and jeopardizing sustainable strategies in the event. of a market correction.

​In Europe, asset managers’ research budgets were cut by more than half between 2016 and 2022, according to estimates by Frost Consulting.

At the same time, the costs of conducting ESG strategies have ballooned as funds have emerged and grown — and could eclipse research budgets by 2024.

“Ironically, European capital managers are less resilient and less sustainable than they were [no início da crise financeira]”, said Neil Scarth of Frost.

ESG strategies incur expenses because of data and research costs, as well as the need to hire management departments to deal with companies on sustainability goals.
“We’re talking to some experienced managers at investment firms that are starting to review the relationship between ESG revenues and costs, in an environment where none of these additional costs are covered by asset owners,” Scarth said.

Translated by Luiz Roberto M. Gonçalves