Lure of higher inflows to fuel ESG fund will launch post-coronavirus, says Fitch Ratings analysis

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TRADITIONAL and alternative investment managers (IMs) able to offer credible environmental social and governance (ESG)-oriented investment options could experience attracting fund inflows and increased investor mandates due to shift in attitudes towards sustainable investing in recent years, Fitch Ratings says.

Recently announced fund launches and/or fundraising plans by large IMs may be delayed by the coronavirus pandemic, according to the American credit rating agency.

However, the longer-term focus on ESG should continue to be supported by increased pressure on governments to correlate stimulus aid to emission controls, evolving consumer behaviour and the attitudes of younger generations as they increasingly benefit from the transfer of wealth from baby boomers.

In certain respects, the coronavirus may further fuel ESG distinctions to the extent companies’ activities and/or behaviours during and after the pandemic influence social perceptions.

ESG offerings related to public equities, and to a lesser extent fixed income, have experienced widespread client mandates and record levels of inflows, which will be a catalyst for increased product offerings by global IMs in coming years.

That said, public equity and fixed-income ESG index funds have only delivered modest out-performance, largely attributable to the under-performance of energy investments in recent years.

If ESG funds are unable to deliver returns and/or portfolio attributes consistent with investor expectations over a longer period, this could lead to a reversal of asset flows, while creating reputational and/or legal challenges for fund managers.

Traditional IMs are further along the asset gathering spectrum for ESG strategies than alternative IMs, given the relative ease of executing against more liquid investment strategies.

BlackRock, with $7 trillion in AUM, is integrating sustainability across its technology platform, risk management and investment strategies to more than double its ESG-focused ETFs funds over the next few years and increase sustainable assets to $1 trillion by 2030 from the current $90 billion.

According to Morningstar, flows into sustainable funds in the U.S. totalled $21.4 billion in 2019, a nearly fourfold increase over the previous year.

At Dec. 31, 2019, 564 traditional funds with $933 billion in collective AUM had ESG considerations in prospectus language, up from 81 funds in 2018.

Fitch believes alternative IMs are in a unique position to drive ESG outcomes given the control positions taken, the level of engagement with management teams across portfolio companies and the potential to leverage operational capabilities.

Many in Fitch’s rated alternative IM universe are launching funds dedicated to ESG strategies, building teams and implementing ESG principles across the investment process, from deal sourcing to exit.

Brookfield Asset Management has long been in the renewables business, with $32.1 billion in renewable power fee-bearing capital while KKR recently closed its inaugural Global Impact Fund at $1.3 billion.

After building out investing platforms, Blackstone and Apollo have both announced plans to launch respective impact funds targeting approximately $1 billion each.

Firms may face reputational risk by greenwashing, or overstating, the upside potential of ESG initiatives or investments, which could lead to long-term damage to the franchise and potentially hurt flows.

That said, firms that have yet to incorporate comprehensive ESG standards into their investment processes could face lower fund flows and reduced fundraising.

Of alternative investors surveyed in a Preqin study, 35% of limited partners have rejected funds for non-compliance with their ESG-related investment guidelines.

Targeted ESG initiatives can also be in conflict with alternative IMs’ broader portfolios, which often contain meaningful oil and gas exposure.

Investments that are not aligned with stated ESG strategies across platforms could see increased investor scrutiny, although investors are likely to grant ample time for portfolio transition, given select limited partners’ goals to transition their own investment portfolios to become carbon neutral by 2050.