Analysis-Investors back ESG stock funds even as tech slide hurts returns

By Simon Jessop and Patturaja Murugaboopathy

LONDON (Reuters) - Investors continued to flock to environmental, social and corporate governance (ESG) stock funds in January despite a slide in Big Tech hitting the funds' performance, and as the market braces for more growth wobbles in the year ahead.

As the global transition to a low-carbon economy gains pace and institutional investors increasingly find themselves graded on the sustainability of their holdings, flows into funds focused on finding ESG winners remained steadfast.

Data shared with Reuters by funds network Calastone, which tracks the trading of units in UK-domiciled funds, shows globally focused ESG stock funds took in a net $622.28 million from Jan. 1 to Feb. 3, compared with $543.56 million flowing to non-ESG stock funds.

Money kept flowing even though January was the worst month in over three years for the technology-heavy Nasdaq index and its tech constituents, favoured by ESG funds for their low emissions and high scores from ESG data providers.

The flows were also buoyed in part by some asset managers re-labelling their plain vanilla funds as ESG funds by changing their investment mandates, which can also involve adopting different benchmarks and shuffling some assets.

Across Europe, more than 500 funds were repurposed in 2021, data from industry tracker Morningstar showed and almost 40% of EU-based assets are now classified as sustainable.

“The sheer number of funds which are assuming the ESG tag, combined with a huge amount of funds industry marketing, and a genuine groundswell of investor interest, are all likely to continue to prop up ESG fund sales irrespective of performance," said Laith Khalaf, head of investment analysis at British investment platform AJ Bell.

The 10 biggest actively managed ESG funds tracked by Morningstar reported an average 9.2% loss in January, much steeper than the 5.3% drop in both the S&P500 and MSCI World indices.

The ESG funds paid the price of their over-allocation to technology stocks; about 28.5% of their portfolio is allocated to the information technology sector on average, compared with 23% for the MSCI World, according to the index provider.

GRAPHIC - Top sustainable funds' performance in Jan.

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An expected rise in interest rates this year, which will make safer assets such as bonds more attractive and riskier assets such as technology stocks less appealing, will test the appetite of ESG funds for technology stocks further.

The relative performance of ESG funds has also been hampered by the aversion of many managers to the fossil fuel industry, which has surged in recent months amid a supply crunch, exchange-traded fund performance data showed.

GRAPHIC - Flows into traditional energy funds vs alternative energy funds

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GRAPHIC - Top outflows from clean energy funds in Jan.

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GRAPHIC - Clean vs Dirty

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Some ESG fund managers have already sought refuge in sectors which provide a hedge against inflation while being friendlier to the environment, such as real estate, Bank of America analysts said in a note to clients.

Cheaper sectors which also score well on ESG, albeit not as good as tech, include luxury goods, media and financials, said Beata Manthey, equity strategist at Citi, adding European stocks were also more attractive over those in emerging markets.

"If you expect the value rotation to continue, the best place to hedge if you are an ESG investor... is going more into financials," Manthey said, and more specifically insurance stocks, although the pace of change will depend on the outlook for real rates.

ESG scores of sectors

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Simon Webber, climate-focused portfolio manager at Britain's biggest listed asset manager Schroders, flagged a healthy pipeline of client interest.

"ESG strengths matter more to the success and evaluation of companies going forward than they have done historically," he said.

That did not necessarily mean loading up on tech stocks, he added, citing opportunities in less favoured sectors such as mining, where he holds a stake in aluminium producer Norsk Hydro.

"They have a very high carbon footprint relative to most things in the market, but... they have a carbon footprint that's around a third of the global aluminium producer average."

"It's exactly the kind of company that needs to be encouraged and supported to help decarbonise the aluminium industry. But if you're trying to optimise your portfolio for carbon footprint, you'll probably ignore the whole sector altogether."

($1 = 0.7368 pounds)

(Additional reporting by Ross Kerber; Editing by Tomasz Janowski)