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Sustainable Investing Opinion Briefs: July 1, 2018 – July 15, 2018

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The Long-Term Performance Record of Vanguard’s FTSE Social Index (VFTSX)
July 9, 2018 – An article in the Philadelphia-based Inquirer written by Erin Arvedlund reported that Dan Wiener, who publishes a monthly Vanguard newsletter, takes a dim view of ESG largely due to under-performance over a long period of time. According to Wiener, such investments “may allow their investors to sleep better at night from a social-conscience point of view, but they aren’t going to put more money in your pocket, they aren’t going to give you more money to direct towards the social, environmental, or governmental issues that matter most to you, and they haven’t had much of an impact, if any, on corporate-governance practices.”

To make the point, Wiener references the Vanguard’s FTSE Social Index (VFTSX), which has been around since May 2000. According to Weiner, the fund has lost ground since 2000 to the tune of 1.0% per year when matched against the S&P 500 Index. He also acknowledges that the Vanguard Social Index Fund did claw back some losses since the latter months of the 2008 bear market, due to heavier stakes in technology and health-care stocks.

In our view, it’s too soon to conclude that investments in funds that consider ESG do not have an impact on corporate-governance practices. Certainly, a broader dialogue around the thesis of profits and purpose is gaining some traction with investors as well as corporations. As for investment funds, the more recent vintage classes of sustainable funds, or funds that emphasize the positive integration of ESG factors and, increasingly, also participate in proactive corporate engagement and proxy voting, in contrast to values-based funds or responsible investing funds that rely entirely or to a large extent on exclusionary practices, have not been around for very long. This makes it challenging to reach a conclusion about their effectiveness at this early date.

As for the long-term performance of the Vanguard FTSE Social Index Fund, while the fund was launched in the year 2000, for the first five years of its operation it was known as the Vanguard Calvert Social Index Fund. At that time, the fund sought to replicate the performance of the Calvert Social Index which favored exclusions. The fund was introduced at an inauspicious time nearly at the start of a three-year market downturn. Effective December 6, 2005, the Calvert Social Index was replaced by the FTSE4Good US Select Index and the fund’s name was updated accordingly. The index is composed of the stocks of companies that have been qualified for inclusion on the basis of certain social and environmental criteria, such as the environment, human rights, health and safety, labor standards, and diversity. The Index also excludes companies involved with weapons, tobacco, gambling, alcohol, adult entertainment, and nuclear power.

It seems that it took the reconstituted fund about 3 years to establish its footing and this affected the fund’s 12-year track record relative to the S&P 500 Index. But when evaluated over a period spanning the last ten calendar years, the Investor Shares (currently at 20 bps) is up 11.33% versus 10.74% for the S&P 500 Index, for a positive differential of 0.59% a year. Over the last 5-years, the same fund is up 14.04% versus the S&P 500 13.32% and over the last 3-years, Investor Shares posted a gain of 13.03% while the S&P 500 Index was up 13.04%.

This ten-year record supports our view that sustainable investment funds which consider certain environmental, social and governance issues and risks in their selection criteria rather than just focusing exclusively or even to a significant extent on exclusionary practices could benefit from exposure to companies focused on profit as well as purpose to produce economic benefits that, in turn, can influence fund performance and allows investment funds to post track records in line with market results. That said, ESG factors alone will not correlate to positive or negative investment results as performance is more likely to be significantly influenced by decisions affecting asset class, factor orientation, sector allocation as well as fundamental stock selection.

Investors Still Not Rushing to Invest in Sustainable Mutual Funds and ETFs
July 5, 2018 – In an article published by Morningstar entitled “5 Things About Sustainable Investing in the First Half of 2018,” the firm reports that in the first five months of 2018, “sustainable funds averaged $924 million per month in net flows. That is nearly twice last year’s monthly average of $532 million.” The article goes on to note that these flows are far more than sustainable funds were getting in the period before the 2016 election.

The figures cited by Morningstar don’t actually jibe with our research and analysis, using Morningstar’s own data. While its evident that assets attributable to sustainable mutual funds, exchange-traded funds and exchange-traded notes have increased by $35.5 billion from $250.4 billion as of December 31, 2017 to $285.9 billion at June 31, 2018, much of this increase is attributable to repurposed funds, that is to say funds that have been in existence previously but have formally adopting one or more forms of sustainable investment strategies reflected in amendments to the fund prospectus. A total of $30.9 billion, or 87% of the total is attributable to 47 funds comprising 215 share classes that have been repurposed or reclassified since the start of the year. On top of that, another estimated $88 million has been added due to market movement during the interval. That leaves a total of about $4.5 billion that is attributable to net new flows during the first six-months of the year, or an average of $750.1 million per month, a number 20% lower than Morningstar’s reported $924 million calculated through the end of May. This figure also suggests that in spite of all the coverage and attention garnered by sustainable funds, investors are still not rushing to invest in the universe of available sustainable investment vehicles, mutual funds and ETFs.

Report in ROBO Global: A Major Shift in Focus Toward ESG Investing Becomes a Top Priority for Corporate and Institutional Investors
July 5, 2018 – Richard Lightbound reports in ROBO Global that he sees a major “shift” in focus toward ESG investing such that it is ”becoming a top priority for corporate and institutional investors alike”. His informal survey at a recent conference in Australia leads him to conclude that ESG is delivering on its promise “to create a better world while offering the potential for highly competitive returns”. One can only hope, but we reserve our opinion until the sustainable fund industry has aged a bit. At the very least, the performance history for ESG funds is too short and limited to too few market condition to draw any conclusions. Their lasting effects on sustainable business practices will also take time to evaluate fully.

Rothschild Identifies Several Impedances that could Slow ESG investing’s Going Mainstream
July 3, 2018 – In an interview in CityWire, Carole Tanguy-Lepy of Rothschild identifies several impedances that could slow ESG investing’s going mainstream. Among these is the need for ESG strategies to show “positive impact and superior performance” while managing risk. She sees that generally, the asset management industry is moving to respond to investors desires for ESG integration, but she also sees the need for increased transparency when using these strategies. The need to capture and measure ESG impacts is of growing importance. For the institutional market we view these considerations as being critical. For retail investors and those distributing to them, we see the need to combine fund performance and ESG impacts as a necessary and complementary set of services.

Cerulli Reports that 55% of Asset Managers Feel that Lacking ESG Related Company Data will be Less of a Barrier in 2 years
July 2, 2018 – A report by Cerulli finds that 55% of asset managers feel that lacking ESG related company data will be less of a “barrier” in 2 years. This is seen as a major step toward increasing managers’ use of quantitative models when assessing ESG investment factors. The lack of consistent ESG data among companies is believed to cause investment bias, especially toward large-cap stocks. It will improve “how asset managers integrate ESG” according to the report. We agree, but believe that the quantitative analysis of ESG factors should be consciously tempered for qualitative considerations. We think that a too heavy reliance on the quantitative assessment of ESG factors could lead to incomplete and possibly misleading conclusions.

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