Home Blog

ESG Integration Should Not To Be Confused with Responsible Investing Practices

An article by Vito J. Racanelli entitled “A Setback for ESG in California” that appeared in last week’s November 5, 2018 edition of Barron’s on the subject of the California Public Employees’ Retirement System (CalPERS) election last month that resulted in the ouster of board president Priya Mathur, a 15-year veteran and a strong champion of the public pension fund’s focus on ESG investing and her replacement, Jason Perez, a critic of this focus, perpetuates an increasingly common misunderstanding by conflating ESG integration for the purpose of properly evaluating investment risks with social or ethical investing practices.  Even as the elements of what constitute E, S and G are still being debated, the idea of ESG integration, in line with the CFA Institute’s definition, is to take into consideration, in a systematic and consistent manner, any relevant and material environmental, social and governance risks or opportunities. The consideration of ESG issues in investment analysis is intended to complement and not substitute for traditional fundamental analysis that might otherwise ignore or overlook such risks or opportunities. On the other hand, ethical or social investing relies primarily on screening out or excluding companies from investment portfolios for a variety of reasons, including ethical, religious, social as well as other strongly held beliefs, such as environmental concerns or involvement on the part of companies in specific business activities. These may include companies involved in the production or manufacturing of tobacco, firearms, alcohol, or even fossil fuel companies, to mention a few.

The misunderstanding is not surprising as ESG has a definition problem. As reported recently in a joint CFA and PRI publication entitled “ESG Integration in the Americas: Markets, Practices and Data,” a coherent understanding is lacking among asset owners, asset managers, issuers and retail investors of what is meant by ESG…” Further, even when ESG is integrated into the equity and fixed income investing process, challenges remain. Two important ones involve time horizon and materiality. Many ESG issues, particularly environmental issues, are long-term in nature and analysis or investment decisions are often undertaken with a shorter time frame. In the case of long-term bonds or similar financial instruments, confidence in outcomes associated with long-term scenarios diminishes and so there is a tendency to discount the results so that near-term outcomes play a more dominant role in the analysis. Another issue is the lack of a generally accepted definition for materiality which needs to be expressed in terms of its linkage to cash flows and risk.

In the same research article, it is noted that investment practitioners may not be able to quantify the precise impact of ESG, but there was agreement that ESG integration can give a more complete understanding of an investment. Indeed, in equity and fixed income investments, risk management was cited as the most important driver of ESG integration in US capital markets while lack of data and a limited understanding of ESG issues and ESG integration were cited as the greatest barriers to ESG integration in US capital markets. Refer to Table 1 and Table 2.

Table 1:  Drivers of ESG Integration in US Capital Markets

Source: ESG Integration in the Americas: Markets, Practices and Data, 2018 CFA Institute

Table 2:  Barriers to ESG Integration in US Capital Markets

Source: ESG Integration in the Americas: Markets, Practices and Data, 2018 CFA Institute

In the case of the California Public Employees’ Retirement System (CalPERS) with its long-term pension liabilities, ignoring environmental risks due to climate change that are projected to have greater impacts sooner, for example, could potentially further serve to exacerbate the retirement fund’s already underfunded status.

2018 USSIF Report On US SRI Trends Shows Assets Reaching $12 Trillion

The Forum for Sustainable and Responsible Investment (USSIF) released its 2018 Biennial Foundation’s “Report On US Sustainable, Responsible and Impact Investing Trends.” The Report, based on data collected and analyzed through the beginning of 2018, disclosed that assets linked to sustainable, responsible and impact investing (SRI) strategies have reached $12.0 trillion, up 38% percent from $8.7 trillion in 2016. According to USSIF, this represents one in four dollars out of the $46.6 trillion in total assets under professional management in the United States. The report notes that “asset management firms and institutional investors are addressing a diverse set of environmental, social and governance concerns across a broader span of assets than in 2016. Many of these money managers and institutions, concerned about racial and gender discrimination, gun violence and the federal government’s rollbacks of environmental protections, are using portfolio selection and shareowner engagement to address these important issues.”

Much of this growth, per the report, is driven by asset managers, who now consider environmental, social or corporate governance (ESG) criteria across $11.6 trillion in assets, up 44% from $8.1 trillion in 2016. The top three issues for asset managers and their institutional investor clients are climate change/carbon, tobacco and conflict risk. While we are challenged to understand the absolute numbers, especially when juxtaposed against mutual funds and ETFs that are classified as sustainable investments which stand at only $312.6 billion as of September 30, 2018 and account for a small 1.5% fraction of combined long-term mutual fund and ETF assets, the overall increase reported by USSIF is consistent with the growing attention directed at SRI investing linked to a range of strategies and practices encapsulated in SRI, from values/faith-based and social investment strategies, exclusionary practices, ESG integration, impact/thematic investing, to shareholder engagement and proxy voting. Regardless of the top line numbers, however, we believe that perhaps as much as 50% of the assets sourced to SRI strategies are likely linked to exclusionary practices, such as tobacco, weapons and alcohol, to mention just some.

Among money managers, social factors were incorporated into investment decisions at a level slightly more than environmental and governance criteria. Social criteria incorporation by money managers increased 39% from 2016 to $10.8 trillion. That said, tobacco-related restrictions saw the greatest growth of any ESG criteria, increasing 432% from 2016 to $2.9 trillion.

The Report’s Executive Summary further discloses that $8.6 trillion of the assets, or 74%, were managed on behalf of institutional investors and $3.0 trillion were managed on behalf of individual investors. A total of $2.6 trillion, or 22%, were managed through registered investment companies such as mutual funds, exchange traded funds, variable annuities and closed-end funds. Here is where our view starts to diverge from USSIF. According to our research, based on Morningstar data, at the end of December 2017, a date intended to approximate USSIF’s early 2018 date for the report terminal date, assets sourced to sustainable investing strategies of mutual funds, ETFs and ETNs stood at $250.4 billion, including $243.1 billion in mutual funds and $7.3 billion in ETFs and ETNs. While this number excludes variable annuities and closed-end funds, we doubt that the difference of $2.3 trillion is explained by these investment products alone. While sustainable assets under management increased some 65.6%, over the two-year interval to December 2017, gaining 28% in 2016 and 30% in 2017, a significant component of that increase is linked to the repurposing of existing funds as well as fund reclassifications. As a percentage of industry assets under management (AUM), sustainable mutual funds and ETFs continue to represent just a small 1.3% fraction of the universe, up from 1.01% at the end of 2015. Refer to Chart 1.

USSIF’s report will receive much coverage in the weeks and months ahead and the base-line number of $12 trillion in SRI assets will be widely quoted until the next USSIF survey is published. While we believe SRI in its various forms and strategies has and will continue to gain traction, especially ESG integration, the reported aggregate AUM and top line growth in AUM doesn’t as yet align with what is being observed through the lens of mutual fund and ETF assets under management. At the same time, the role of retail investors, in particular, remains muted and likely calls for greater educational efforts and the expansion of product offerings.

Monthly Sustainable Cash Flows: September 2018

Black and white numbers background. 3d rendered illustration

Summary

  • Sustainable funds close September having achieved another high point with $321.9 billion in assets under management, up $11.4 billion of which $10.99 billion, or 96%, is sourced to repurposed funds; in the third quarter, net assets expanded by $36 billion, with 60% attributable to repurposed funds.
  • Sustainable funds registered an average gain of 2.14% in September, ranging from 17.17% to -3.87% while the SUSTAIN Equity Fund Index added 2.79%, lagging behind the S&P 500 by 47 basis points.
  • Top 10 performing funds/share classes over the 12-months to September 30, 2018: Performance ranges from 25.99% to 228.44%. These funds vary in their approach but cover the full range of sustainable investing strategies and practices.
  • Sustainable fund groups expanded to an adjusted 119 firms with the addition of Jensen Investments and Calamos Advisors.
  • Top 20 sustainable fund groups account for $279 billion or 86.7% of segments assets under management; top 10 firms manage $231.5 billion, or 72%.
  • Largest monthly net gains recorded by American Funds Washington Mutual and various TIAA-CREF and DFA funds.
  • Largest monthly declines were recorded by Vanguard, Aberdeen and Morgan Stanley funds
  • Repurposed funds add 8 funds, 31 share classes and $11.0 billion in assets under management to the sustainable investing sector.
  • New Funds: Three new funds launched in September, including the Vanguard ESG US Stock ETF, Vanguard ESG International Stock ETF and Impact Shares.

Sustainable funds closed September having achieved another high point with $321.9 billion in assets under management, up $11.4 billion of which $10.9 billion, or 96%, is sourced to repurposed funds
The net assets of 1,096 sustainable funds[1], including mutual fund share classes, exchange-traded funds (ETFs) and exchange-traded notes (ETNs), ended the month of September with $321.9 billion in assets under management versus $310.5 billion at the end of August.  The increase in net assets for the month, in the amount of $11.4 billion, was sourced to repurposed funds that added a total of $10.99 billion attributable to three fund firms, including two new fund group additions to the sustainable funds segment, and a total of eight funds and 31 share classes in total.  In addition, the segment benefited from an estimated positive net cash flow in the amount of $1.65 billion, including the launch of three new ETFs in September, while market movement contributed to a decline in assets to the tune of about -$1.2 billion.  Refer to Chart 1.

Shifting to a third quarter view, sustainable funds, in the aggregate, experienced the best quarter-over-quarter growth in net assets fueled in large part by repurposed funds, followed by market movement and positive cash inflows. Net assets expanded by $36.0 billion, versus an uptick in the amount of $21.6 billion in the first quarter and $13.9 billion in the second quarter.

Repurposed funds added $21.6 billion in the third quarter, accounting for 60% of the gain while market movement added $9.8 billion, or 27.2%, followed by net positive cash flows in the amount of $4.6 billion, or 12.8%.

Mutual fund assets stood at $312.6 billion as of the end of September while ETFs and ETNs closed the month at $9.3 billion, for increases of $11.2 billion (3.7%) and $220.7 million (2.3%), respectively, relative to last month. The relative proportion of the two segments remain unchanged at about 97% and 3%, respectively. Assets sourced to institutional only mutual funds/share classes, 408 in total, versus all other funds gained $7.6 billion, or 7.4%, to $110.3 billion.  This investor group accounts for 34.2% of the segment’s assets, versus $102.7 billion at the end of August.

Sustainable funds registered an average gain of 2.14%, ranging from 17.17% to -3.87% while the SUSTAIN Equity Fund Index added 2.79%, lagging behind the S&P 500 by 47 basis points
Within a universe of 1,059 sustainable funds with performance for the full month, including mutual funds, exchange-traded funds (ETFs) and exchange-traded notes (ETNs) and their corresponding share classes, returns for the month of August, hampered by the performance of non-US stocks, averaged 0.83% versus last month when sustainable funds, on average, posted a gain of 2.14%. A total of 739 funds, or 70%, posted 0.00 to positive results for the month.

Economic growth momentum and a sturdy fundamental backdrop of strong corporate earnings, low unemployment and contained inflation overcame a number of challenges to bolster stock results in the US. The Federal Reserve also fueled momentum, with news that it remains accommodative on the monetary policy front.  Interest rates are being lifted slowly and predictably while the Fed’s balance sheet is being trimmed in a similarly deliberative fashion.

The SUSTAIN Equity Fund Index, which tracks the total return performance of the ten largest actively managed large-cap US, gained 2.79% in August, lagging behind the S&P 500 by 47 basis points and in the process widened the difference between the two indexes to 4.60% since December 31, 2016. At the same time, the SUSTAIN Bond Fund Indicator recorded an increase of 0.66% in August, beating the Bloomberg Barclays U.S. Aggregate Bond Index. Refer to Chart 2.  See also SUSTAIN Equity Fund Index Gains 0.27% in September but Lags S&P 500.

Top 10 performing funds/share classes over the 12-months to September 30, 2018: Performance ranges from 25.99% to 228.44%
The top 10 performing sustainable funds over the one-year period to September 30, 2018, including mutual funds, ETFs and ETNs, posted an average return of 48.69%. Even excluding the outsized 228.44% return recorded by the small $10.8 million iPath Global Carbon ETN, the universe of these ten funds based on the best performing share class, if applicable, registered an average gain of 28.72%. Refer to Table 1.

With the exception of the iPath Global Carbon ETN that provides exposure to the global price of carbon by referencing the price of carbon emissions credits from the world’s major emissions related mechanisms, these top performing funds invested in growth oriented securities that had been qualified on the basis of each fund’s sustainable strategy. These varied as set forth in Appendix 1, ranging from values/religious-based strategies that rely primarily on exclusions to funds that integrate ESG and pursue shareholder engagement and proxy voting practices. By way of comparison, growth companies, as measured on a total return basis by the S&P 500 Growth Index, were up 25.21% during the 12-month interval to September 30, 2018.  In each instance, the top ten performing funds/share classes exceeded the performance of the S&P 500 Growth Index.

Sustainable fund groups expanded to an adjusted 119 firms with the addition of Jensen Investments and Calamos Advisors
Explicitly designated sustainable mutual funds and ETFs/ETNs are offered by a universe of 119 fund group (as adjusted) as of September 30th, reflecting an increase of two fund groups.  Both fund groups, Jensen Investments and Calamos Advisors, repurposed 2 mutual funds consisting of 7 share classes in total that added $7.2 billion to the existing universe of sustainable funds.  At the same time, Dreyfus, which had already been offering the Dreyfus Sustainable US Equity Fund (originally the Dreyfus Third Century Fund, launched in 1999, until its name change as of May 2017), weighed in with an explicit ESG amendment to the prospectus covering six additional funds managed by Newton Investment Management, a Dreyfus subsidiary, with total net assets of $6.9 billion.

Top 20 sustainable fund groups account for $279 billion or 86.7% of segments assets under management
The sustainable funds segment is highly concentrated. The top 20 sustainable fund groups held $278.9 billion in assets under management, accounting for 86.7% of the segment’s assets versus $274.1 billion the prior month.  The top 20 funds added a net of $10,987.6 million, representing 96.5% of the segment’s net gain of $11.4 billion.  Refer to Table 2.

There was a shift in the rankings of the top 20 fund groups, attributable to the repurposing of funds by Jensen and Dreyfus that between these two firms added a combined total of $10.7 billion. In the process, Jensen now ranks 9th largest sustainable fund group in terms of assets under management while Dreyfus shifted in rank to 17th.  In the process, Amana and Eventide fund groups were shifted out of the ranks of the top 20 firms.

Within this segment, the top 10 firms dominate with $231.5 billion in assets under management or 72% of the segment’s total AUM.

Largest monthly net gains recorded by American Funds Washington Mutual and various TIAA-CREF and DFA funds
The following fund firms and funds contributed to the largest gains attributable to market movement, positive flows or repurposed funds, or some combination these factors:

  • Again this month, the largest monthly net gain, in the amount of $941.8 million, was realized by the American Funds $11.03 billion Washington Mutual Fund, a fund offered by American Funds that excludes companies deriving a majority of their revenues from alcohol or tobacco products. The fund group’s Washington Mutual Fund is the only fund in the group that is explicitly described as a sustainable fund. While slightly down from last month’s 35.2%, the fund accounts for 34.3% of the sustainable segment’s assets under management.
  • The second largest monthly gain was realized by TIAA-CREF that added $116.4 million in net assets. The largest net inflow was sourced to the TIAA-CREF Social Choice Bond Fund that added $65.1 million in net assets, including $45.1 million allocated to the institutional share class. The Social Choice Equity Fund also benefited from a net inflow into the institutional share class, attracting $39.1 million.
  • Dimensional Fund Advisors achieved a net gain of $113.9 million in net assets, with four funds contributing in excess of $10 million each. These include, in descending order, DFA International Social Core Equity Institutional ($49.4 million), DFA International Sustainability Core 1 ($31.50 million), DFA US Sustainability Core 1 ($29.40 million) and DFA Social Fixed Income Institutional ($16.20 million).

Largest monthly declines were recorded by Vanguard, Aberdeen and Morgan Stanley funds
The following fund firms and funds experienced the largest net outflows due to a combination of market depreciation and cash outflows:

  • The $4.8 billion Vanguard FTSE Social Index Fund sustained a $330.3 million net decline in assets, entirely attributable to the institutional share class that saw a net decline in the amount of $394.4 million. This was offset by a $41.5 million net increase sourced to the fund’s investor share class.
  • Aberdeen Funds experienced a decline in net assets in the amount of $294.9 million. The largest contributors to the fall off included Aberdeen Emerging Markets Fund ($178.5 million), Aberdeen Small Cap Equity Institutional Fund ($59.0 million) and Aberdeen Total Return Bond Fund ($35.10 million).
  • Morgan Stanley sustained a net decline in the amount of $263.3 million, largely attributable to three funds. These include the Morgan Stanley Global Real Estate Fund ($86.3 million), Morgan Stanley Institutional Emerging Markets Fund ($75.4 million) and the Morgan Stanley Institutional Frontier Markets Fund ($62.3 million).

Repurposed funds add 8 funds, 31 share classes and $11.0 billion in assets under management to the sustainable investing sector
Three fund firms repurposed existing mutual funds in the month of September, expanding the sustainable sector with the addition of 8 funds X in assets under management. These include the following:

  • Portland, Oregon-based investment manager of two mutual funds, Jensen Investment Management, adopted an ESG integration approach for its $$6.9 billion Jensen Quality Growth Fund, consisting of 4 share classes, as of September 30, 2018.
  • Dreyfus, manager of the long-lived Dreyfus Sustainable US Equity Fund, repurposed six funds, consisting of 24 share classes with total net assets in the amount of $3.8 billion, each one managed by Newton. In a prospectus amendment dated September 21, 2018, the fund manager added: Integrated into the investment process, Newton has a well-established approach to responsible investment. This process includes identifying and considering the Environmental, Social and Governance (ESG) risks, opportunities and issues throughout the research process via Newton’s proprietary quality reviews, in an effort to ensure that any material ESG issues are considered.”
  • Calamos International Growth Fund, a $276.7 million fund managed by Calamos Advisors LLC, adopted the following ESG integration language: The investment adviser takes environmental, social and governance (“ESG”) factors into account in making investment decisions.

New Funds: Three new funds launched in September include the Vanguard ESG US Stock ETF, Vanguard ESG International Stock ETF and Impact Shares

  • The Vanguard ESG US Stock ETF and ESG International Stock ETF track the performance of the FTSE US All Cap Choice Index and FTSE Global All Cap ex US Choice Index that, with regard to ESG, are screened for certain environmental, social, and corporate governance (ESG) criteria that relies on an approach by which the stocks of companies in the following industries are excluded: adult entertainment, alcohol and tobacco, weapons, fossil fuels, gambling, and nuclear power. The index methodology also excludes the stocks of companies that do not meet the labor, human rights, environmental, and anti-corruption standards as defined by the United Nations Global Compact Principles, as well as companies that do not meet certain diversity criteria.

It should be noted that these approaches to ESG contrast with the methodology pursued by the Vanguard FTSE Social Index Fund that, in addition to excluding certain companies, largely relies on the integration of ESG factors.

  • Impact Shares. The fund is intended to exhibit risk and return characteristics similar to those of the Morningstar Global Markets Large-Mid Index with a universe of companies that (i) display a commitment to the UN’s Sustainable Development Goals, (ii) adhere to the principles of the UN Global Compact, (iii) display a commitment to reducing poverty and supporting economic development globally and (iv) have exposure to countries with low levels of socioeconomic development. For additional information on the selection criteria, refer to the Sustainable Investment Glossary under the Investment Research/The Basics tab.

 

[1] Morningstar recorded 1,101 funds, including 5 share classes offered by the Franklin Select US Equity Fund with $99.8 million in assets that had been repurposed as of August.  These are excluded from the analysis as their most recent prospectus does not reflect the adoption of a sustainable strategy or approach.

ESG Liquidity Fund Targeted to Institutional Investors Offered by DWS

Summary
DWS launched an institutional money market fund that integrates environmental, social and governance considerations while at the same time employing exclusionary screens. This $329.3 million fluctuating Net Asset Value (NAV) fund contrasts with the stable value GuideStone Money Market Fund that pursues a values/religious-based approach.  Other significant differences extend to eligible security types, minimum investments and expense ratios.

DWS, formerly Deutsche Asset Management, made its sustainable investing debut in the US last month by repurposing the firm’s existing $329.3 million DWS Variable NAV Money Market Fund
DWS, formerly Deutsche Asset Management, made its sustainable investing debut in the US last month by repurposing the firm’s existing $329.3 million DWS Variable NAV Money Market Fund, an institutional money market fund that integrates environmental, social and governance (ESG) considerations while at the same time employing exclusionary screens[1]. Refer to Chart 1 for ESG definitions.  The DWS ESG Liquidity Fund, which charges an expense ratio of 98 basis points (bps) but is limiting fees to 10 bps pursuant to an 88 bps fee waiver in effect at least until September 30, 2019, has also recalibrated its minimum investment to $10 million effective as of October 15, 2018.  As of September 30, 2018, the fund is generating a 7-day yield of 2.16%[2]. While not the only sustainable money market fund offering available to investors in the US, this fund’s strategy relies on ESG integration rather than emphasizing a values-based approach pursued by the GuideStone Money Market Fund.  The fund is strictly geared to institutional investors, it invests in a broader range of money market instruments and is subject to a fluctuating versus a stable net asset value.  As such, it is expected to generate a higher net yield. The fund’s launch is timely, as short-term interest rates are rising while sustainable investing strategies among institutional investors continues to gain traction. It therefore would not be surprising to see more offerings in this class over time, especially if the fund is successful in accumulating assets under management (AUM).  DWS, like BlackRock, is a highly regarded liquidity manager.  The fund’s capacity to attract ESG sourced AUM will, in part, depend on the effective execution of its ESG strategy.  On this score, time will tell.

DWS ESG Liquidity Fund invests in a variety of short-term instruments and will maintain strict quality and maturity limits
The DWS ESG Liquidity Fund invests in high quality, short-term, US dollar denominated money market instruments, including obligations of US and foreign banks, corporate obligations, US government securities, municipal securities, repurchase agreements and asset-backed securities, paying a fixed, variable or floating interest rate. At the time of purchase, eligible securities will have remaining maturities of 397 days or less, or have certain maturity shortening features (such as interest rate resets and demand features) that have the effect of reducing their maturities to 397 days or less. The fund will maintain a dollar-weighted average maturity of 60 days or less and 120 days or less determined without regard to interest rate resets.

In addition to considering financial information, the security selection process also evaluates a company based on ESG criteria
According to the fund’s prospectus which became effective September 1, 2018, in addition to considering financial information, the security selection process also evaluates a company based on ESG criteria. With the exception of municipal securities, a company’s performance across certain ESG criteria is summarized in a proprietary ESG rating which is calculated by an affiliate of the DWS on the basis of data obtained from various ESG data providers. Only companies with an ESG rating above a minimum threshold determined by DWS are considered for investment by the fund. The proprietary ESG rating is derived from multiple factors:

  • Level of involvement in controversial sectors and weapons;
  • Adherence to corporate governance principles;
  • ESG performance relative to a peer group of companies; and
  • Efforts to meet the United Nations’ Sustainable Development Goals.

ESG ratings for municipal securities are calculated by DWS by applying a combination of positive and negative screens. From the investable universe of municipal securities, positive screens will automatically include green bonds (bonds that intend to finance projects that are expected to produce positive environmental and/or climate benefits) that meet minimum standards and negative screens will exclude municipal securities with exposure to weapons, issues where more than 10% of the business is attributable to nuclear power or more than 25% of the business is derived from coal, and issues related to gambling, lottery, the production or sale of tobacco, and other sectors deemed controversial by DWS.

The remainder of the investable universe of municipal securities are then scored on key performance indicators in each of three pillars: environmental, social and corporate governance. Only municipal securities with a cumulative score across all three pillars above a minimum threshold determined by DWS are considered for investment by the fund.

Comparison of key fund considerations
DWS ESG Liquidity Fund is the second only sustainable money market fund offering available today in the US, however, when compared to the GuideStone Money Market Fund, the fund offerings differ in some significant ways. While not the first to be launched, the $1.1 billion GuideStone Money Market Fund, which is sub-advised by BlackRock, has been available since 2009.  Unlike DWS ESG Liquidity Fund, GuideStone pursues a values/religious-based approach that is intended to align investments with Christian values. GuideStone funds may not invest in any company that is publicly recognized, as determined by GuideStone Financial Resources of the Southern Baptist Convention (GuideStone Financial Resources), as being in the alcohol, tobacco, gambling, pornography or abortion industries, or any company whose products, services or activities are publicly recognized as being incompatible with the moral and ethical posture of GuideStone Financial Resources. There are other differences between the two funds, and these are summarized in Table 1.

 

[1] DWS also launched the Xtrackers MSCI EAFE ESG Leaders Equity ETF.
[2] Source: Crane Data.

Monthly Sustainable Portfolios Performance Summary: September 2018

Summary

  • Buoyed by robust economic growth and strong corporate earnings, the S&P 500 Index eked out narrow gain of 0.57% in September even as US stock markets reached all-time new highs.
  • Bonds closed the month lower, posting negative results of -0.66% but recording a slight third quarter gain of 0.01%.
  • Positive fundamentals shift investor sentiment moving into month-end: US economic growth, strong corporate profits and strong consumer confidence overcame trade, inflation and interest rate concerns.
  • The SUSTAIN Equity Fund Index gained 0.52% in September and 7.71% in the third quarter, lagging behind the S&P 500 by 30 bps and 60 bps, respectively.
  • In contrast to equity funds, intermediate-term investment grade sustainable bond funds outperformed the Bloomberg Barclays US Aggregate Index in September, albeit by a narrow margin of 5 basis points.
  • Sustainable model portfolios lagged their respective indexes in September, posting results that range from a positive 0.21% to -0.37%.
  • Sustainable funds closed September at another high point at $321.9 billion, up $11.4 billion of which $10.9 billion, or 96%, is sourced to repurposed funds.

Buoyed by robust economic growth and strong corporate earnings, the S&P 500 Index eked out narrow gain of 0.57% in September even as US stock markets reached all-time new highs
Performance in September across asset classes, geographic regions and styles covered a narrower 16% arc that ranged from a high of 6.85% posted by the price of Brent crude oil to a negative -9.1% recorded by the MSCI India Index. Within this range that saw more negative returns than positive and growth stocks outperforming value-oriented stocks, the S&P 500 Index eked out a narrow gain of 0.57% in September even as US stock markets reached all-time new highs. Sustainable funds and ETFs recorded an average drop of -0.37%. Sustainable funds and ETFs[1] recorded an average drop of -0.37%. Beyond the month of September, the S&P 500 recorded the best quarterly increase since 2013, up a strong 7.71%, buoyed by robust economic growth and strong corporate earnings.  For the year-to-date and trailing 12-month intervals, the index produced strong gains of 9.94% and 16.11%, respectively.  On the other hand, small company stocks, as measured by the Russell 2000, posted their second worst decline this year.  The -2.4% September drop narrowed the year-to-date outperformance of small firms relative to large ones and given their declining relative performance differentials may be signaling a loss of momentum for small stocks.  Refer to Chart 1.

Bonds closed the month lower, posting negative results of -0.66% but recording a slight third quarter gain of 0.01%
Bonds closed the month lower, posting negative results of -0.66% against a backdrop of rising yields due to increasing interest rates, continued optimism about the domestic economy and waning fears about the outlook outside the US. As measured by the Bloomberg Barclays US Aggregate Index, investment-grade intermediate bonds finished the quarter with a slight gain of 0.01% while year-to-date and trailing 12-month results ended lower at -1.60% and -1.22%, respectively.  Longer dated 30-year bonds were off 6.53% year-to-date.  Concurrently, some indexes around the globe have struggled with a slowdown in economic expansion and a stronger US dollar.  The MSCI Emerging Markets Asia posted a decline of -1.69% while MSCI China recorded a loss of -1.4%.  At the same time, the MSCI EAFE Index edged out the S&P 500 with a gain of 0.87% in September.

Positive fundamentals shift investor sentiment moving into month-end: US economic growth, strong corporate profits and strong consumer confidence overcame trade, inflation and interest rate concerns
After a weak start to the month when investors returned from the Labor Day weekend to be greeted by news about the bear market in emerging markets, highflying tech names such as Facebook, Inc. (FB), Microsoft Corp. (MSFT) and Alphabet, Inc. (GOOGL) sold off and then rebounded. The selling reversed itself and stocks indexes powered higher despite the Trump Administration’s imposition of 10% tariffs on $200 billion of Chinese products that were countered by China’s retaliation with 5%-10% levies on $60 billion of U.S. goods. It turned out, however, that the tariffs were less severe than expected and trade tensions, while they continue to linger, didn’t escalate as much as feared while the dollar continued to ease. With that, investor sentiment turned and the focus shifted to positive fundamentals, such as US economic growth, strong corporate profits that are expected to expand by a projected 19% from a year earlier, and strong consumer confidence.  This was fueled by the Labor Department’s end of month report that the number of Americans filing for unemployment benefits unexpectedly fell and hit the lowest level in nearly 49 years—pointing to robust labor market conditions.  The positive outlook was reinforced toward the end of the month when the Federal Reserve Board described economic conditions as “strong.” This was communicated in conjunction with the Fed’s announcement of the widely expected increase to 2% -2.25% of its benchmark interest rate, for the eighth time since 2008, and signaling that it planned to continue to raise interest rates.  The Fed also updated the economic projections from members of the Fed’s Board of Governors and regional Fed presidents. The most notable change in this set of projections was a steep upgrade in expectations for economic growth this year. Fed officials’ median forecast now calls for GDP growth to hit 3.1% in 2018, up from 2.8% in June’s projections and substantially higher than the Fed’s forecast for 2.5% GDP growth this year at the end of 2017.

These developments drove the US stock market higher, pushing both the S&P 500 Index and the Dow Jones Industrial Average to reach new all-time highs as of September 20. The Nasdaq Composite pierced through its all-time high the day before.  Since then, however, the markets have backed off as investors have begun to reassess the potential for higher interest rates and inflation.

The SUSTAIN Equity Fund Index gained 0.52% in September and 7.71% in the third quarter, lagging behind the S&P 500 by 30 bps and 60 bps, respectively
Against this backdrop, the SUSTAIN Large Cap Equity Fund Index, which tracks the total return performance of the ten largest actively managed large-cap U.S. equity oriented mutual funds that employ a sustainable investing strategy beyond absolute reliance on exclusionary practices, registered a gain of 0.52% in September and 7.71% in the third quarter. This was 30 basis points behind the increase of 0.57% posted by the S&P 500 Index in September and 60 bps behind the S&P 500 in the third quarter.

In contrast to equity funds, intermediate-term investment grade sustainable bond funds outperformed the Bloomberg Barclays US Aggregate Index in September, albeit by a narrow margin of 5 basis points
In contrast to the relative performance of equity funds, intermediate-term investment grade sustainable bond funds outperformed the Bloomberg Barclays US Aggregate Index in September, albeit by a narrow margin of 5 basis points. The SUSTAIN Bond Fund Indicator, which represents the total return performance of a cohort of five sustainable bond funds consisting of similarly managed funds that, like the equity index counterpart, employ sustainable investing strategies beyond absolute reliance on exclusionary practices that track the Bloomberg Barclays U.S Aggregate Index, posted a decline of -0.59% in September versus -0.64% generated by the Bloomberg Barclays U.S. Aggregate Index. Extending the time frame beyond the latest month, the SUSTAIN Bond Fund Indicator also outperforms the Bloomberg Barclays index in the third quarter, year-to-date and 12-month intervals. That said, the results achieved by both over the last twelve months have been negative. Refer to Chart 2.

Sustainable model portfolios lagged their respective indexes in September, posting results that range from a positive 0.21% to -0.37
The Aggressive Sustainable Portfolio (95% stocks/5% bonds), Moderate Sustainable Portfolio (60% stocks/40% bonds) and the Conservative Sustainable Portfolio (20%/80%) produced total returns in September that range from a high of 0.21% to a low of -0.37%. These outcomes trailed behind each portfolio’s designated benchmark as the three underlying funds fell behind in September. Refer to Table 1. While the results are more robust, the same is true for the third quarter when the portfolios recorded gains ranging from 2.03% for the Conservative Sustainable Portfolio to 6.07% posted by the Aggressive Sustainable Portfolio. Refer to Table 1.

The model portfolios’ relative performance results are mixed when evaluated over the nine-month and 12-month intervals through September as the returns posted by Domini Impact International Equity Investors shares fell behind the MSCI EAFE Index (NR) by 2.34% and 3.78%, respectively. Still, since inception, the three model portfolios are leading their respective benchmarks by wide margins, ranging from 8% for the Conservative Sustainable Portfolio to as much as 19.4% for the Aggressive Sustainable Portfolio. Refer to Chart 3.

Sustainable funds register average gain of 0.37% and performance ranged from 3.13% to -5.85%
Sustainable mutual funds, exchange-traded funds (ETFs) and exchange-traded notes (ETNs) posted an average gain of 0.37%, with 47% of funds recording results ≥0.00%

The top performing funds/share classes in September were the five share classes offered by the very small $1.6 million Aberdeen Japanese Equity Fund whose performance ranged from 3.13% to 3.04% due to upfront as well as deferred sales charges, versus the MSCI Japan (NR) Index that gained 3.04%. Managed by Aberdeen Standard Investments, the fund, according to its prospectus, employs a fundamental, bottom-up equity investment process that also fully integrates environmental, social and governance (ESG) considerations into investment decisions for all equity holdings.  Further, this represents an integral component of the manager’s quality rating for all companies.

At the other end of the performance range in September were the $1.1 billion Morgan Stanley Institutional Emerging Markets Leaders Fund and Dreyfus Global Emerging Markets C shares. These funds registered declines that averaged -5.76% versus the MSCI Emerging Markets (NR) loss in September of -0.53%.  While their performance in September were in line with each other, the approaches being taken by the two funds with regard to ESG vary.  Morgan Stanley Investment Management Company takes into account information about environmental, social and governance issues when making investment decisions, including engaging company management around corporate governance practices as well as what Morgan Stanley deems to be materially important environmental and/or social issues facing a company. The investment process also excludes holdings in tobacco companies. In contrast, the Dreyfus Global Emerging Markets Fund emphasizes governance considerations as well as a focus on investment themes based primarily on observable global economic, industrial, or social trends.  Refer to Table 2.

Sustainable funds close September at another high point at $321.9 billion, up $11.4 billion of which $10.9 billion, or 96%, is sourced to repurposed funds
The net assets of 1,096 sustainable funds[1], including mutual fund share classes, exchange-traded funds (ETFs) and exchange-traded notes (ETNs), ended the month of September with $321.9 billion in assets under management versus $310.5 billion at the end of August.  The increase in net assets for the month, in the amount of $11.4 billion, was sourced to repurposed funds that added a total of $10.9 billion attributable to three fund firms, including two new fund group additions to the sustainable funds sphere, and a total of eight funds and 31 share classes in total.  In addition, the segment benefited from an estimated positive net cash flow in the amount of $1.65 billion, including the launch of three new ETFs in September, while market movement contributed to a decline in assets to the tune of about -$1.2 billion.  Refer to Chart 4.

Mutual fund assets stood at $312.6 billion as of the end of September while ETFs and ETNs closed the month at $9.3 billion, for increases of $11.2 billion (3.7%) and $220.7 million (2.3%), respectively, relative to last month. The relative proportion of the two segments remain unchanged at about 97% and 3%, respectively. Assets sourced to institutional only mutual funds/share classes, 408 in total, versus all other funds gained $7.6 billion, or 7.4%, to $110.3 billion.  This investor group account’s for 34.2% of the segment’s assets, versus $102.7 billion at the end of August.

At the end of September, the universe of explicitly designated mutual funds and ETFs/ETNs were sourced to 120 firms[2], including the addition the Jensen and Calamos fund groups with their repurposed funds while three new ETFs were launched, including the Vanguard ESG International Stocks ETF and Vanguard ESG US Stock ETF as well as the Impact Shares Sustainable Development Goals Global Equity ETF.

[1] 1,091 funds reported performance results for the full month of September 2018.  Further, 5 share classes offered by the Franklin Select US Equity Fund with $99.8 million in assets are excluded from the September analysis as their most recent prospectus does not reflect the adoption of a sustainable strategy or approach.

[2] BlackRock and iShares are treated as two separate fund groups.

 

 

 

 

 

 

 

 

The SUSTAIN Equity Fund Index Gained 0.27% in September but Lags S&P 500

Summary

  • Buoyed by robust economic growth and strong corporate earnings the S&P 500 Index eked out a narrow gain of 0.57% in September even as US stock markets reached all-time new highs. For the quarter, the index is up a strong 7.71%.
  • On the other hand, investment-grade intermediate bonds closed the month lower, posting negative results of -0.66%. As measured by the Bloomberg Barclays US Aggregate Index, investment-grade intermediate bonds finished the quarter with a slight gain of 0.01% while year-to-date and trailing 12-month results ended lower at -1.60% and -1.22%, respectively. Longer dated 30-year bonds were off 6.53% year-to-date.
  • The SUSTAIN Equity Fund Index gained 0.27% in September and 7.11% in the third quarter, lagging behind the S&P 500 by 30 bps and 60 bps, respectively.
  • In contrast to the performance of equity funds, intermediate-term investment grade sustainable bond funds outperformed the Bloomberg Barclays US Aggregate Index in September, albeit by a narrow margin of 5 basis points.

Buoyed by robust economic growth and strong corporate earnings, the S&P 500 Index eked out a narrow gain of 0.57% in September even as US stock markets reached all-time new highs
Performance in September across asset classes, geographic regions and styles covered a narrower 16% arc that ranged from a high of 6.85% posted by the price of Brent crude oil to a negative -9.1% recorded by the MSCI India Index. Within this range that saw more negative returns than positive and growth stocks outperforming value-oriented stocks, the S&P 500 Index eked out a narrow gain of 0.57% in September even as US stock markets reached all-time new highs. Sustainable funds and ETFs recorded an average drop of -0.37%. Sustainable funds and ETFs[1] recorded an average drop of -0.37%. Beyond the month of September, the S&P 500 recorded the best quarterly increase since 2013, up a strong 7.71%, buoyed by robust economic growth and strong corporate earnings.  For the year-to-date and trailing 12-month intervals, the index produced strong gains of 9.94% and 16.11%, respectively.  On the other hand, small company stocks, as measured by the Russell 2000, posted their second worst decline this year.  The -2.4% September drop narrowed the year-to-date outperformance of small firms relative to large ones and given their declining relative performance differentials may be signaling a loss of momentum for small stocks.

Bonds also closed the month lower, posting negative results of -0.66% against a backdrop of rising yields due to increasing interest rates, continued optimism about the domestic economy and waning fears about the outlook outside the US. As measured by the Bloomberg Barclays US Aggregate Index, investment-grade intermediate bonds finished the quarter with a slight gain of 0.01% while year-to-date and trailing 12-month results ended lower at -1.60% and -1.22%, respectively.  Longer dated 30-year bonds were off 6.53% year-to-date.  Concurrently, some indexes around the globe have struggled with a slowdown in economic expansion and a stronger US dollar.  The MSCI Emerging Markets Asia posted a decline of -1.69% while MSCI China recorded a loss of -1.4%.  At the same time, the MSCI EAFE Index edged out the S&P 500 with a gain of 0.87% in September

The SUSTAIN Equity Fund Index gained 0.27% in September and 7.11% in the third quarter, lagging behind the S&P 500 by 30 bps and 60 bps, respectively
Against this backdrop, the SUSTAIN Large Cap Equity Fund Index, which tracks the total return performance of the ten largest actively managed large-cap U.S. equity oriented mutual funds that employ a sustainable investing strategy beyond absolute reliance on exclusionary practices, registered a gain of 0.27% in September and 7.11% in the third quarter 2018. This was 30 basis points behind the increase posted by the S&P 500 Index and 60 bps behind in the third quarter. Refer to Table 1.

Just three of the ten funds that comprise the SUSTAIN Equity index outperformed the S&P 500 while four funds outperformed the index in the third quarter. Calvert Equity Class A led with a strong gain of 1.21%, followed by the Dreyfus Sustainable US Equity Z shares, up 1.06%, and Parnassus Fund, up 0.85%.  Calvert has been a consistent outperformer and is the only SUSTAIN index member to eclipse the S&P 500 fund in each of the four time intervals under consideration in the last year.  In fact, the fund has outperformed the S&P 500 in eight of the last 12-months.  That said, the Dreyfus Sustainable US Equity Fund Z shares has been gaining momentum and it has exceeded the performance of the S&P 500 during each of the last four-months.  The fund, which was reorganized as of May 1, 2017 and in August dropped one of its supporting portfolio managers (refer to SUSTAIN Equity Index Gains 1.35% in May but Lags S&P 500 by Almost 1.1%), now ranks as the best of ten SUSTAIN index fund performers in the third quarter with its gain of 9.34%. The fund has been benefiting from increased positions in relatively defensive industry groups, such as pharmaceutical developers and utilities, while also moving the fund’s sector allocations to positions more closely approximating those of the S&P 500.  Still, the fund maintained above index exposures to firms like Microsoft Corp. (MSFT), Apple, Inc. (AAPL) and Alphabet Inc. A (GOOGL) which accounted for 7.47%, 5.81% and 5.36% of fund assets, respectively, as of August 31, 2018.

At the other end of the performance range for the month are three funds that each posted negative results in September. The first of these, the Neuberger Berman Sustainable Equity Fund Institutional Class, dropped -0.76% in September while also posting the lowest return for the quarter of 4.69%. The fund has been hampered by its non-US stock exposure, which stood at 12.54%.  Also detracting from performance have been the fund’s overweight position in Financial Services, the worst performing sector in September, down -3.35%, and its underweight position in technology stocks.  The second fund, the Parnassus Endeavor Fund which invests in a limited number of high conviction large-capitalization companies that represent Parnassus’ clearest expression of ESG investing, returned -0.67% in September and 5.35% in the third quarter. The fund’s below benchmark 12-month performance stands in contrast to the impressive performance achieved over the previous 3, 5 and 10-year intervals. It also stands in contrast to  the same fund group’s Parnassus Fund that turned in the third best SUSTAIN Equity Index results in September, up 0.85%.  The third fund, Domini Impact Equity Fund Investor Shares was down -0.19%. In early September Domini announced that effective December 1, 2018 State Street Global Advisors will be replacing Wellington Management Company, the fund’s subadvisor since May 2009.

The SUSTAIN Equity Fund Index is up 8.82% on a year-to-date basis and has posted a strong 14.87% total return over the preceding 12-month period. While two index members, namely Calvert Equity A and Pax Large Large Cap Fund Institutional shares eclipse the S&P 500 during the two time intervals, the SUSTAIN index tails the S&P 500 by expanding margins of 1.74% and 3.04%, respectively.  Since the inception of the index as of December 31, 2016, the negative variation stands at 5.02%. Refer to Chart 1.

In contrast to equity funds, intermediate-term investment grade sustainable bond funds outperformed the Bloomberg Barclays US Aggregate Index in September by 5 basis points
In contrast to the relative performance of equity funds, intermediate-term investment grade sustainable bond funds outperformed the Bloomberg Barclays US Aggregate Index in September, albeit by a narrow margin of 5 basis points. The SUSTAIN Bond Fund Indicator posted a decline of -0.59% in September versus -0.64% generated by the Bloomberg Barclays U.S. Aggregate Index. Against a backdrop of rising yields due to increasing interest rates, continued optimism about the domestic economy and waning fears about the outlook outside the US investment-grade intermediate bonds negotiated an about face versus last month’s 0.64% gain.  Refer to Chart 2.

Extending the time frame beyond the latest month, the SUSTAIN Bond Fund Indicator also outperformed the Bloomberg Barclays index in the third quarter, year-to-date and 12-month intervals. The results achieved by both benchmarks over the last twelve months, however, are negative.

Calvert Bond I sustained the narrowest loss in September and led in the nine-month and 12-month periods. This $1.1 billion intermediate-term fund maintained an average effective duration of 5.08 and BBB average credit quality, with about 43% of assets invested in corporate bonds and 32.3% in securitized bonds, mainly asset backed securities and 18.84% in US government securities.

PIMCO Total Return ESG Institutional led in the third-quarter, however, the $1.1 billion fund trails the other four funds that make up the SUSTAIN Bond Fund Indicator over the preceding 12 months. Relative to Calvert, the fund maintained a lower average effective duration of 4.09 given the firm’s view that the risk of rising inflation remains. Also, while investment-grade corporate credit exposure was roughly in line, the PIMCO fund was overweight agency MBS Pass-Through securities that stood at around 53% versus Calvert’s 0.52%.

The Sustainable (SUSTAIN) Bond Fund Indicator represents the total return performance of a cohort of five sustainable bond funds consisting of similarly managed funds that, like the equity index counterpart, employ sustainable investing strategies beyond absolute reliance on exclusionary practices that track the Bloomberg Barclays U.S Aggregate Bond Index. These include: Calvert Bond I, Pax Core Bond Fund International, PIMCO Total Return ESG Institutional, Praxis Impact Bond I and TIAA-CREF Social Choice Bond Institutional.

[1] Representing 1,091 sustainable funds, ETFs and ETNs with performance data for the entire month of September.

Latest on the Blog

Follow Us

56FansLike
1,199FollowersFollow
432FollowersFollow
450FollowersFollow