Refinitiv Lipper’s analysis of environmental, social, and governance (ESG) investments in the UK market for 2021.
It’s been a year of contrasts—probably the most restrained thing one can say of 2021. While flows into ESG equity funds dominated, taking £33.5bn over the year—with £22.7bn into the Equity Global classification alone—there are signs that bonds are starting to accelerate. Flows more than doubled the year’s takings in the fourth quarter, from £3.2bn between January and September to £6.8bn by year end.
This contrasts with performance: the ‘dirty’ stocks of oil and gas companies drove returns for the year, as alternative energy suffered. It’s likely that much of this is to do with the growth bias of many ESG funds in an environment where value has rebounded after a good many years in the doldrums. As inflation digs its claws in, this may continue. If so, ESG funds’ returns may begin to lag over the longer term, as we’ve seen for 12-month performance. This begs the question of whether ESG is necessarily a growth play. Recent research from Robeco analyses the trade-off between a high value exposure and a low carbon footprint, and finds that carbon taxes up to $100 correspond to a portfolio carbon footprint reduction of about 50% without impacting portfolio earnings yield to a significant degree.[1]
What remains to be seen is whether the green/growth, brown/value binaries start to decouple as this analysis suggests they could.
Lastly, despite an acceleration of ESG asset gathering, I do not believe we’re seeing an ESG bubble. Yes, the alternative energy debacle in Q1 showed that specific areas of the market will become very frothy at times. Should investors worry about the valuations of certain stocks and sectors? That’s always wise. Does this mean that there is a general ESG bubble? No, not least because the investment needed to meet the goals of the Paris Agreement is still way off of where we are currently. The challenge is to connect supply with demand to meet both sustainability targets and investors’ risk profiles and diversification needs.
Value Rally Erodes Growth-Tilted ESG Lead
- Asset Class: Aside from money market funds, all ESG flows were positive. There is a stark flow out of “regular” (-£33.2bn) ethical funds into green ones (£33.5bn).
- Global Equity flows, at £22.7bn, were greater than the combined flows of the following nine largest money takers over 2021. Investors aren’t swapping brown for green within equity classifications, but shifting classifications as they “go green”.
- Performance: While ESG funds in the top-three selling classifications outperform over three and five years, the rally of value since late 2020 has seen the performance of “brown” funds in these classifications make a comeback.
- Asset Manager: BlackRock took the largest net assets over 2021, at £8.8bn. It saw inflows of more than £10bn in ESG equity assets.
ESG v Conventional Flows by Asset Class
Chart 1: Asset Class Flows, ESG v Conventional, FY 2021 (£bn)
Source: Refinitiv Lipper
Over the first three quarters of 2021, bond fund sales were £3.2bn ESG and £7.2bn non-ESG. There’s been something of a rotation over the fourth quarter, as full year sales now stand at £6.8bn to £6.5bn, respectively. Bond flows for the full year have, as a result, overtaken ESG mixed assets, which they were lagging the previous quarter. We’d previously speculated that the relative paucity of fixed income product relative to equity may have caused the slower uptake of the former. Figures show that’s changing. At the end of Q3, there were 42 ESG bond funds. By the end of Q4, there were 53—up almost a quarter over three months.[2]
As previously, ESG mixed assets flows are marginally ahead of their vanilla peers, at £6bn versus £5.5bn, respectively.
But, as you can see, the real action is with equities, where ESG funds have seen inflows of £35bn and outflows of £33.2bn over the year (up from £26.82bn and £21.22bn for the first three-quarters of the year). This has been a consistent trend over many months. Investors aren’t simply trading like-for-like as they go green, however, but seem to be using a shift in sector classification as a chance to upgrade to ESG along the way—something we’ll look at in greater detail below. The number of equity ESG options for investors are also increasing, from 237 (end Q3 2021) to 274 (end Q4 2021).
Alternative ESG is still struggling to make a dent in flows, taking in just £207m over the year. That’s unsurprising, given that there are only three ESG options for the asset class.
ESG/Non ESG Flows by Classification
Chart 2: Largest Positive ESG Flows by Refinitiv Lipper Global Classification, FY 2021 (£bn)
Versus Conventional Equivalents
Source: Refinitiv Lipper
The top money taker, Equity Global, for the year exceeds that of the other nine on Chart 2, at £22.7bn to £19.5bn. Some 95 of the 274 equity ESG funds are global, reflecting this popularity. “Brown” global flows, on the other hand, have seen outflows of £3.5bn. While Equity UK remains deeply unloved, at £9.8bn in outflows despite a reasonably good year in performance terms, the classifications ESG funds have netted £3.4bn over the year. Similar stories—negative overall flows versus positive ESG, can be seen with Bond GBP Corporates (-£2.2bn to £1.7bn) and Equity US (-£5bn to £1.1bn).
Equity Theme—Alternative Energy flows have slowed markedly over the course of the year (Q1-Q3, £2.5bn versus £2.9bn for the full year), following a collapse in asset values over the first quarter, and it’ll be interesting to see how long it takes investors to return in significant number to what is, after all, a key area for mitigating climate change.
Regarding mixed assets, most flows go to conventional funds in the aggressive space, while ESG wins out in balanced. There’s a similar number of funds in each classification, and when last we looked at this across mixed asset classifications the ESG performance kicker for both classifications were proportionally broadly the same. It’s something of an anomaly as to why ESG balanced should not have the same pull.
On the other hand, the only significant outflows over the year have been from Money Market GBP (£2.3bn), which reflects the overall flows from the classification. In general, negative ESG flows reflect the direction of travel in the overall classification, notable exceptions being Mixed Asset Other Flexible and Mixed Asset GBP Flexible, which have seen combined outflows of £636m, while their conventional peers have taken £1.4bn.
Chart 3: ESG Top-Selling Classification Performance versus Conventional Equivalents,
FY 2021 (Percentage Growth)
Source: Refinitiv Lipper
Chart 3 takes the top-three selling sectors over the year and compares the ESG and non-ESG performance within these classifications over one, three, and five years.
Over the three- and five-year periods, ESG funds have outperformed across all three classifications, from between 13.2% (Equity UK, three years) to 35% (Mixed Asset GBP Balanced over five).
Over one year, it’s a different story, with ESG Mixed Assets a couple of basis points behind their conventional peers, and “brown” Equity UK beating its ESG equivalent by 25%, although Equity Global ESG retains a lead. As value outperformed over much of the year, the more growth-tilted ESG funds lagged. For example, over three and five years, Technology and Telecoms have been the winning fund categories—over one year, Commodities and Natural Resources significantly outerpformed them, as the Nasdaq saw its worst start to the year since 2008. On the other hand, certain old economy sectors—oil, gas, and shipping, for example—are benefitting from the revival in economic activity and the various supply chain bottlenecks this is encountering.
The question then is, if rising rates through 2022 create an environment more favourable to value (and, by implication, non-ESG funds), will ESG see its lead eroded?
Chart 4: ESG Active v Passive Asset Class Flows, FY 2021 (£bn)
Source: Refinitiv Lipper
At the end of Q3 2021, passive funds looked to be snapping at the heels of active managers, with 39% and 45% of total ESG flows. While passive equity has more or less held its own—at 44% for the full year—passive bond funds’ share of the sustainable market has slipped to 21%. While net flows for passive bond ESG funds did increase over the final quarter—by £199m—their share slipped as fixed income flows more than doubled over the final quarter, from £3.2bn to £6.8bn.
Flows by Asset Manager
Chart 5: Largest Positive ESG Flows by Promoter, FY 2021 (£bn)
Source: Refinitiv Lipper
BlackRock heads up the asset manager flows for the year, at net £8.8bn. All of this and more can be ascribed to equity products (£10.9bn), with £660m going into bond funds. Over the year, net flows were impacted by £2.7bn from money market vehicles. Elsewhere in the top 10, Liontrust has the largest mixed-assets take (£2.3bn) followed by Royal London (£2.1bn), while Aegon attracted the greatest flows to bond funds (£1,8bn).
Appendix:
UK SFDR Registered Funds
Chart 6: SFDR Article 8 and 9 Funds Registered for Sale in the UK (Count)
Source: Refinitiv Lipper
Chart 7: SFDR Article 8 and 9 Funds Registered for Sale in the UK (AUM, £bn)
Source: Refinitiv Lipper
Although the UK isn’t signed up to SFDR, a significant number of asset managers have designated their funds as either Article 8 (light green) or Article 9 (dark green) under the EU regulation.
That amounts to 62.5% of assets flagged by Refinitiv Lipper as ethical, and 8.3% of total UK assets.
In total, 152 funds—13 Article 8 and 139 Article 9—have signed up, with £163.7bn and £15.9bn in assets under management, respectively. Equities comprise the largest number of funds (84), and the largest number of assets (£65.7bn). Next follow money market (£61.7bn), bond (£28.3bn), mixed-assets (£18.5), and alternatives (£5.5bn). And, as can be seen, the high concentration and volume of money market assets accounts for the significant difference with the Article 8 bar on charts 7 and 7.
Last October, those figures were money market (£58.9bn), followed by equity (£25bn), mixed-assets (£11.8bn) and then bond (£5.9bn), so there’s been substantial change in a relatively short period of change, though we would anticipate that new designations of existing funds should stabilise early in 2022.
[1] Hat tip to Joachim Klement at the Klement on Investing blog for highlighting this: https://klementoninvesting.substack.com/p/going-green-as-a-value-investor
[2] UK registered for sale, GBP currency of record, primary share class with Ethical flag
