Diverging regulation and reliance on tech stocks could hurt ESG returns, say experts, as study shows funds ‘overestimate impact by 10%’

A number of studies have been released over the past week suggesting vulnerabilities in ESG funds’ performance and impact claims. 

Experts at ratings agency Fitch said they anticipated “risks and potential returns” as a result of diverging regulatory approaches in Europe and the US.

The analyst note contrasts the “conservative stance” of US worker pensions watchdog the Department of Labor to ESG, including recent moves to restrict the ability of workplace pensions to invest in ESG funds and vote on ESG matters, with the ambitious approach of EU regulators. 

It warns that EU initiatives such as the reform of Markets in Financial Instruments Directive (MiFID) II rules, could increase compliance costs for asset managers and result in “additional litigation and reputational risk” if financial and ‘non-financial’ targets were not met.

“While these differing approaches are not expected to immediately affect ratings assigned to investment managers, pension funds and/or the institutions sponsoring such plans, we anticipate they will translate into differing investment considerations, risks and potential returns over the longer term,” the analysts concluded, adding that they expected the interest in ESG to continue to grow. 

Separately, analysis from global banking network the Institute of International Finance (IIF) attributed the dip in global ESG fund performance earlier this month to the outsized influence of technology companies in many portfolios. The headwinds, it said, were a result of a tech stocks sell-off in September that highlighted the “increasing importance” of tech firms in benchmark ESG indices. In a sample size selected by the IIF, 75% of sustainable equity funds had reported diminished returns as a result of the volatility.

The analysis also compared the market performance between equities with similar ESG ratings and found that stocks ranked best  ̶  all tech  ̶  also had the sharpest losses this year. The report concludes  that “relative performance of ESG focused equities may not be as stellar as suggested”.

Meanwhile, impact fund Snowball released an assessment of the additional impact that the fund managers in its own portfolio bring to investments. It found that “fund managers overestimate the impact they bring to their investments by an average of 10%” when compared with best practice.

The analysis covered 21 unnamed fund managers, looking at their impact self-assessments against an in-house framework from Snowball, whose investors include Friends Provident Foundation and Skagen Conscious Capital.

“Fund managers are not performing as well as they think they are,” said Snowball, but it added that there were efforts to improve.

Private debt managers displayed the strongest performance on impact, while public debt managers scored lowest for “investor contribution”.

“Middle-aged managers outperformed younger and older fund managers,” it added. ‘Middle-aged’ was defined as those operating between five and 20 years.

Specialist managers “significantly outperformed” their generalist peers.  

Abigail Rotheroe, Snowball’s Investment Director, said: “We are looking for impact focussed pioneers that walk the walk – they take their stewardship responsibilities seriously and want to grow the impact investing market because this is the future of investment – not just another product offering. By sharing our approach and results, we hope to spark debate and improvement.”