Majority of ESG funds outperform wider market over 10 years

Close to six out of 10 sustainable funds delivered higher returns than equivalent conventional funds over the past decade, according to a study that undermines claims that investing based on environmental, social and governance principles hampers performance.

ESG funds have exploded in popularity in recent years as emergencies such as climate change have pushed individuals to invest according to their values. Despite this, debates have persisted over whether a link exists between investing responsibly and achieving outperformance.

But research from data provider Morningstar examining the long-term performance of a sample of 745 Europe-based sustainable funds shows that the majority of strategies have done better than non-ESG funds over one, three, five and 10 years.

The analysis carries weight as up until now there has been limited data on sustainable funds’ long-term performance due to the relatively short track records of many strategies and huge variety in ESG approaches.

“The findings debunk the myth that there is a performance penalty associated with ESG investing,” said Hortense Bioy, director of passive strategies and sustainability research at Morningstar.

“ESG factors are not just ‘nice to have’ but drivers of outperformance,” said Jan Erik Saugestad, chief executive of Storebrand Asset Management. “It is both right and smart to exclude certain business practices in violation with well recognised conventions or with inherent high risk and negative impact.”

Sustainable funds’ rates of success varied depending on the asset class. Of the seven asset classes examined by Morningstar, US large-cap blend equity funds that invest sustainably were the best performers, with more than 80 per cent of funds in this category beating their traditional peers over 10 years.

However, only three in 10 euro corporate bond funds achieved better returns than their non-ESG funds over the same period.

The study showed that sustainable funds also outpaced traditional funds during the market sell-off sparked by coronavirus in the first quarter, notching up average excess returns of up to 1.83 per cent.

ESG funds’ low exposure to oil and gas gave them an edge at a time when energy stocks suffered steep losses, said Ms Bioy. However, she noted that even excluding the unusual market conditions unleashed by the pandemic, the majority of sustainable funds in the study still beat traditional funds over the long term.

Morningstar found that sustainable funds have greater survivorship rates than non-ESG vehicles. On average, 77 per cent of ESG funds that were available 10 years ago still exist, compared with 46 per cent for traditional funds.

But Ms Bioy warned that as asset managers launched more funds to meet growing investor demand, survivorship rates were likely to go down. Up until now, ESG funds have been less vulnerable to the commercial pressures that lead managers to close funds, due to their niche status and loyal, institutional client base, but this will change as the strategies move into the mainstream.