Environmentally friendly investments attracted new interest in a brutal first quarter. But there are still plenty of skeptics.
You might think saving the world would take a back seat to saving the portfolio as Covid-19 wreaks havoc with high-net-worth fortunes. You would be wrong. Portfolios that temper the total-return imperative with environmental, social or governance objectives proved stickier than others through the first half-year of the pandemic, private banks found.
That suggests an enduring future growth opportunity. “Outflows from ESG funds have been less than from non-ESG funds,” says Nalika Nanayakkara, leader of the Wealth and Asset Management practice at Ernst & Young in New York. “People buy them for other than market reasons.”
In Europe, ESG funds actually gained €27 billion ($29.5 billion) in new assets during 2020’s tumultuous first quarter, while the larger mutual fund sector suffered €210 billion in net withdrawals, reports Fabrizio Zumbo, research director for the continent at Cerulli Associates. That capped five years of 20% annual growth, with “private banks being one of the prime distribution channels.”
But there is a lot of market share left to grab. Even in Europe, considered the global leader in socially oriented capitalism, the discipline has captured just 6% of invested wealth, Zumbo says.
Better yet, ESG might be the most effective bridge to a younger generation of rich individuals inclined to look askance at their parents’ wealth management. “Older people come in and say, ‘My daughter participated in a climate demonstration, so I have to do something about it,’” says Jan Amrit Poser, head of sustainability at Bank J. Safra Sarasin in Zurich. There’s also a geographical wave to ride, he says, as ESG consciousness spreads from progressive bastions like Scandinavia and the US coasts to semi-virgin territory in the US interior and ex-Japan Asia.
Less obvious is exactly what ESG means and how banks can shape an offering that stands out from the great green crowd. This starts with recognizing that investors are not all the same.
Institutional investors favor diversified, integrated portfolios that weigh ESG scores against other factors in deploying capital, or screened funds that exclude black-hat industries like fossil fuels and tobacco, Zumbo says. But individuals are drawn to themed investments that give a more palpable sense of promoting a cause. The most popular themes—no surprise—are environmental and low carbon. Funds promot-ing other ESG trends like gender diversity or fair labor practices run far off the pace.
That’s old news at Safra, which launched its Climate Active Strategy in 2019. Now the bank is slicing and dicing off subthemes, like a basket of companies that promote clean water. Next up, topically, is a Future of Health Fund focused on smaller-cap pharmaceutical innovators and perhaps a biodiversity fund, Poser says.
Winning Over the Skeptics
ESG still has a big hurdle to jump with investors: proving it can be a good strategy for wealth accumulation as well as the soul. Myriad market studies reached no firm conclusion on this, and purveyors of capital have noticed. Despite its surface appeal to younger individuals, less than a quarter of surveyed investors believe ESG “can improve alpha opportunity,” Zumbo notes, and more than half fear it “lacks a track record.”
Besides investors themselves, the skeptics include many private-bank relationship managers, according to Poser. “A lot of the client advisers don’t even ask if the clients are interested,” he says. “They consider that it’s too complicated.”
But the sudden scourge of Covid-19, and the suggestion that humans’ impact on the natural world could make such outbreaks more likely in the future, may add to the ranks of those willing to give ESG the benefit of the doubt. “Two big lessons from this crisis are, listen to the scientists, and a massive global response is possible,” Poser argues. “There’s a clear parallel there with climate change.”
Clear or not, the ESG trend hit its first serious test with the pandemic—and it passed.