What are ESG funds? How do these increasingly popular investments work, and how much do they yield compared to traditional funds?
Among the most popular sustainable finance instruments are ESG funds.
For those who are not yet familiar with these particular types of investments, we can first of all state that these are portfolios of shares and/or bonds selected based on compliance with environmental, social and governance criteria.
This means that the shares and bonds contained in the fund belong to companies and corporations with low environmental impact, committed to respecting workers’ rights and with transparent and correct managerial management.
The propensity to make one’s savings grow through assets and securities that are virtuous in environmental and social terms is growing in Europe. Although there are still some skepticism about the ability to concretely verify the benefits of an ESG investment, Nordea’s Survey ESG Adviser 2024 report showed a lively interest in these tools.
Looking at the world, according to Morningstar data, in the third quarter of 2024 ETFs and ESG funds attracted investments of 10.4 billion dollars, a figure greater than both the flows of the second quarter ($6.3 billion) and the first quarter ($4.8 billion).
In Europe, the flow towards these portfolios focused on environmental, social and governance sustainability reached 10.3 billion dollars (9.71 billion euros). Although declining in the third quarter, the value remains very important, so much so that the old continent is considered the largest ESG fund market in the world, with 84% of assets under management.
Precisely because of this significant weight in the global investment landscape, knowing in detail what ESG funds are, how they work and how much they yield is crucial for those who want to invest their savings in a careful and advantageous way.
What are ESG funds?
A simple definition of ESG funds identifies them as:
a mixed portfolio of shares and bonds belonging to companies that have passed tests on environmental sustainability, respect for social rights and good governance practices.
The fund, therefore, invests exclusively in well-selected assets, based on ESG criteria that go beyond financial evaluation.
In essence, those factors considered traditional in the choice of investments - yield, risk calculation, duration - are no longer the only ones contemplated by the saver. So-called ethical parameters become fundamental drivers in the choice of the fund to which to direct one’s savings.
ESG funds invest in shares or bonds of companies and/or countries that are concretely committed to environmental sustainability, social progress and honest and transferable business management.
How do ESG funds work?
In order to clarify how ESG funds work, it is necessary to summarize the meaning of the parameters that make them unique, namely the environmental, social and governance ones.
Here is what the ESG criteria are:
- Environmental parameter: includes all the objectives and activities related to the reduction of pollution, sustainable waste management, energy efficiency, biodiversity conservation;
- Social parameter: refers to good corporate or country practices regarding respect for workers’ rights, gender equality, social well-being;
- Governance parameter: this criterion mainly evaluates transparency, honesty, and fairness in corporate management
ESG funds consider valid investment options in their portfolios mainly companies that have a solid track record in these three parameters.
To do this, they use groups of expert analysts who have the task of monitoring the market in search of virtuous companies. Faced with the evolution of ESG criteria and their widespread diffusion in finance, companies today are obliged by European regulatory constraints to draw up detailed reports on the achievement of social, environmental and governance objectives.
Therefore, ESG funds are increasingly in demand and present in the panorama of investment options.
How much do ESG funds yield
ESG funds are not risk-free, like any other investment, but over time they have proven to be able to generate interesting earnings, even higher than those of conventional investments.
According to an analysis shared by several experts, some peculiarities of ESG funds make them more attractive in terms of returns than others.
First of all, the companies that perform best on ESG criteria that are included in the fund are those that probably manage risks more effectively. In essence, they are companies that are less exposed to paying fines for excessive pollution, to union protests to claim more rights, to lawsuits by shareholders for poor transparency in governance.
Furthermore, thanks to high ESG ratings, a company can obtain solid profits and cash flows, less exposed to shocks and with more certain future prospects. According to some studies, for example, companies with very high ESG ratings also guarantee a 30% premium compared to less virtuous ones.
To understand how much ESG funds yield, you can rely, for example, on the performance of the MSCI World SRI Index, the largest index in the world composed of stocks oriented towards ESG criteria.
In 2023, the gross return of this basket was around 28% compared to 24% for the MSCI World index (an index of large and mid-cap stocks in developed market countries).
In detail, the MSCI World basket of stocks (which provides a general overview of the overall performance of stocks in global markets) has offered a return of 62.46% from 2019 to date.
In comparison, the MSCI World SRI, a global benchmark for ESG stocks, has had a return of 73.43% over the same period.
It should be noted that the two indices are not perfectly comparable, since the MSCI World index is much broader and moves 10 times greater cash flows than the other index.
In any case, it is understandable that the returns of ESG funds are now considered very attractive.
Original article published on Money.it Italy. Original title: Fondi ESG, cosa sono, come funzionano e rendimento
