Three powerful trends driving shift to index funds for responsible investing. 

Investor interest in environmental, social and governance (ESG) investing has been growing steadily for some time. But despite the potential of feel-good outcomes and better investment performance, ESG investing has been met largely with indifference. 

Without a compelling reason to act, ESG has been easy to ignore. That is, until now.

2020 has exposed some very real health, social, financial and political inequities around the world. Focusing on these injustices has provided an opportunity to gain greater clarity about the values most important to each of us. 

As with every major turning point in history, there comes a time for less talk and more action – and the current health crisis has indeed sparked a collective demand for change. 

Although the ESG tide has been rising for decades, we believe ESG investing has now reached a critical inflection point. Investors’ lingering reservations about such investments seem to have eased and they are increasingly ready to take a stand with their investment choices. 

We believe it is time for ESG investing to move from a check-the-box component of investment portfolios to a must-have ingredient.

What ESG is

Some think it is all about investing for impact. Others think it is about imposing a certain set of values on companies.

ESG investing is about informing better decision-making by adding the assessment of material environmental, social and governance issues into the investment process. It enriches traditional research such as analysing financial statements, industry trends and company growth strategies.

Benefits and risks 

Interest in ESG has been growing for some time – and not only because urgent issues such as climate change have highlighted the importance and necessity of ESG investing, but because the benefits of this approach are attractive. 

ESG investing comes with the feel-good factor that your investment may be helping the environment and building a better future for the next generation, or it may be tackling crucial social issues and encouraging a more diverse and inclusive workplace. ESG investing provides a more holistic view of a company, its risks, and its opportunities. 

As a result, more and more investors have made the choice to switch to ESG investing – and they have been met with a flood of ESG funds to choose from. 

Although choice can at times be a good thing, wide-ranging ESG definitions, debates about terminology and data – and data quality in particular – and an explosion in investment selections have created more confusion than conviction. 

Three driving trends

ESG has been on the agendas of international policymakers and institutional investors for decades. But the crisis has undoubtedly revealed individual investors’ collective call for social change. In fact, investors’ current passion for ESG could also unite governments and their people, laying the foundation for even greater change.

We believe this united call for change will be supported by three powerful trends that we expect will drive a nearly eightfold increase in global ESG exchange traded funds (ETFs) and index mutual fund assets — from US$170 billion at 31 May 2020 to more than US$1.3 trillion by 2030 (i). 

1. The great reset in a turbulent 2020

Massive fiscal and monetary policies implemented in the aftermath of the global financial crisis rewarded holders of financial assets but did precious little for the broader economy. 

As a result, ESG challenges festered, which paved the way for the divisive, populist politics that define the current era. All that was needed to fuel the flames was a spark – which COVID-19 and its chain reactions provided.

At the same time, the crisis has underscored how non-financial ESG factors can affect long-term valuation. While ESG’s “E” has been a readily understood and acted-upon element, the pandemic has pulled the “S” and “G” attributes into sharper focus. 

Factors such as a company’s contingency planning and work environment are now top-of-mind for many investors. We believe these ESG issues will differentiate companies to a much greater extent than in the past. 

2. Investors reshaping the investment industry

In the past decade, demand for indexing and transparent rules-based factor investment has permanently changed the investment landscape. Not surprisingly, ETFs and index managed funds have been the primary beneficiaries of this industry transformation. 

However, until recently, investor adoption of ESG ETFs and index managed funds has been, at best, uneven. But the COVID-19 pandemic may be changing investor attitudes toward ESG investing. 

In fact, according to Morningstar, during the first quarter of 2020, ESG funds saw inflows of US$45.7 billion globally – while the broader fund universe had an outflow of US$384.7 billion.

The pandemic environment continues to prompt investors to overcome the traditional obstacles to ESG investing. This transformation is also helping investors to:

• Incorporate ESG factors for more sustainable performance
  
• Rely on better data to make better decisions
• Gain ESG exposure with cost-effective ETFs
• Customise portfolios with ESG funds.

3. Boomers preparing to transfer wealth to their children

We believe ESG investing’s ability to manage risk and create long-term value makes it a clear choice for individual investors, especially families thinking about legacy planning. 

In our view, greater use of ESG, as a quality factor that can improve portfolios and lead to a better world, will have an especially profound effect on society as the greatest inter-generational wealth transfer in history begins. 

In the US, according to Cerulli Associates, Baby Boomers will pass nearly US$48 trillion in assets to their heirs and charities over the next 25 years (ii).  Here, the global pandemic has highlighted an opportunity for investors. 

Stay-at-home orders around the world have resulted in more forced family togetherness. As a result, Boomer parents and their stuck-at-home children are having real conversations about personal values, which have naturally flowed into discussions about estate planning, planned giving and family philanthropy as a means to enact real societal changes. 

In our view, there has never been a greater sense of urgency to act than there is right now – and we expect that the enormous transfer in wealth from Boomers to their children has the potential to fuel incredible growth in ESG investing over the next decade. 

Time to act 

Whether you want to manage risk, express your values, or pursue sustainable performance, ESG investing has the potential to improve your decision-making and support your desire to move society forward.

ESG ETFs are a low-cost solution to begin ESG investing. They are typically structured like managed funds but quoted and traded on an exchange like stocks. 

ESG ETFs typically represent a basket of companies that can target a broad index – and can therefore provide diversified exposure to several companies, meeting certain ESG criteria, via the ASX.  

[i] Source: State Street Global Advisors, June 2020, based on Morningstar data as of 31 May 2020. The forecasted growth uses certain assumptions and analysis made by SSGA. There is no guarantee that the estimates will be achieved.

[ii] Cerulli Associates, U.S. High-Net-Worth and Ultra-High Net-Worth Markets 2018: Shifting Demographics of Private Wealth.

Webcasts

Meaghan Victor, State Street Global Advisors and Stuart Magrath, S&P Dow Jones Indices joined Rory Cunningham at ASX to explore trends in ESG investing and discuss the benefits for investors.

Find out more: 

• S&P/ASX 200 ESG index
• ESG resources from State Street Global Advisors