Is this ESG’s big break?

The performance of environmental, social and governance (ESG) investment funds turned heads in the first half of 2020.

Research from Morningstar found that 24 out of 26 sustainable index funds outperformed their peers in the wake of the Covid-19 market crash. Results like these are helping to dispel the myth that ESG investors are sacrificing returns, according to industry experts.

“There’s no detriment — there’s no downside — to investing through [an] ESG lens,” said Ian Tam, Morningstar’s director of investment research, Canada.

Melanie Adams, vice president and head of corporate governance and responsible investment at RBC Global Asset Management, said that while more research is needed to explain why ESG funds have outperformed, it may be because they’re often heavy in tech stocks, many of which soared during lockdown.

Kevin Prins, head of ETF and managed accounts distribution at BMO Global Asset Management, said the “G” in ESG is particularly important during times of market turmoil.

“What you’re seeing is the governance [factor] coming through and showing that good companies can weather a storm,” Prins said.

Dustyn Lanz, CEO of the Responsible Investment Association (RIA), said that if critics were hoping the Covid-19 crisis would confirm their suspicion that ESG funds underperform, they were in for an unpleasant surprise.

“In reality, the crisis just confirmed what academics and responsible investors have been saying for years: that integrating environmental, social and governance factors into your investment decisions can help you to identify risks and opportunities that are not visible with traditional financial metrics alone,” Lanz said.

Lanz added that ESG metrics allow investors to evaluate companies and their management teams “more holistically.”

The popularity of ESG funds seems to be catching on. According to Morningstar, in the first quarter of 2020, inflows into sustainable funds outpaced inflows for all of 2019.

“This is the big break for the retail market,” Lanz said. “We’ve seen this by the increased fund flows into ESG products according to Morningstar research, and I think the retail market is about to blow up.”

Lanz suggested this could mark a “paradigm shift” in investing. He added that modern technology has brought ESG risks to the attention of investors everywhere.

“We’re in the social media age,” Lanz said. “When a factory collapses, when people are marching in the streets, when there’s a forest fire, plastic washing up on shores — people see this.”

Having geographic diversification in your investment portfolio was a new concept a generation ago, but is now common practice, Lanz noted. ESG integration, he predicted, will eventually become “table stakes” for advisors hoping to attract and retain clients.

“Clients out there are really interested [in ESG],” Adams said. “And advisors are not always prepared to speak to clients [about ESG].”

If you haven’t prepared yourself to talk to clients about ESG, now might be a good time to do just that.

“You actually have to have a thought-out [ESG] process,” Prins said. “This is [a] fundamental change coming to the whole industry.”