Investors are increasingly beginning to incorporate ethical considerations into their investment decisions, a development which has given rise to the ESG framework over the years. Despite the implementation challenges which arise when screening investments against acceptable environmental, social and corporate governance themes, the trend towards a more conscientious approach to investment is here to stay, especially from the perspective of large institutional investors. Fund managers, for both actively and passively managed investment vehicles are balancing their quest for superior returns with the need to meet investor demand for responsible investing. Further, an understanding that such an approach to investment can translate into ‘ESG-induced alpha’ for managers is further helping the cause of ethically guided investing. This piece looks at the performance of funds, both long-only absolute return vehicles and hedge funds, with an active ESG investment framework and how they have performed over the years.
The Eurekahedge ESG Fund Index, which tracks the performance of 991 active fund managers that incorporate ESG frameworks in their investment processes returned 10.31% in the first half of 2021. This compares with the 12.07% and 10.72% return of the MSCI ACWI ESG Leaders Index and the custom Eurekahedge Equity ex-ESG Fund Index2. In 2020, despite recording their worst quarterly performance in the first quarter since Eurekahedge started tracking the industry, the ESG fund managers posted a return of 14.49% throughout the year – their strongest annual performance in over a decade. On a positive note, after their losses in 2018, the ESG compliant managers look to be on track to record three consecutive years of double-digit returns.
Figure 1 below depicts the performance of the Eurekahedge ESG Fund Index versus comparable benchmarks since the end of 2007. Over the period depicted below, the ESG fund managers tracked by the Eurekahedge database have generated an annualised return of 5.44%, ahead of the MSCI ACWI ESG Leaders Index which gained 4.94% per annum. On the other hand, non-ESG peers utilising long/short equities strategy outshined their ESG peers as they have returned 6.09% per annum over the same period.
Figure 1: The Eurekahedge ESG Fund Index performance since 2007
Table 1: Performance in numbers – Eurekahedge ESG Fund Index vs comparable benchmarks
|
|
Eurekahedge ESG Fund Index |
MSCI ACWI ESG Leaders Index |
Eurekahedge Equity ex-ESG Fund Index |
2008 |
(33.39%) |
(41.55%) |
(18.91%) |
2009 |
33.25% |
31.97% |
25.83% |
2010 |
13.32% |
10.43% |
10.81% |
2011 |
(9.35%) |
(8.41%) |
(6.02%) |
2012 |
10.65% |
12.42% |
8.47% |
2013 |
13.66% |
21.91% |
16.13% |
2014 |
3.48% |
2.80% |
3.36% |
2015 |
3.71% |
(4.15%) |
3.50% |
2016 |
9.63% |
5.54% |
3.71% |
2017 |
13.21% |
20.67% |
12.44% |
2018 |
(5.57%) |
(10.43%) |
(6.28%) |
2019 |
12.29% |
24.73% |
11.25% |
2020 |
14.49% |
14.11% |
15.25% |
2021 year-to-date |
10.31% |
12.07% |
10.72% |
2 year annualised return |
14.49% |
17.99% |
15.26% |
2 year annualised volatility |
11.43% |
17.53% |
11.02% |
2 year Sharpe ratio (RFR = 1%) |
1.18 |
0.97 |
1.29 |
3 year annualised return |
10.59% |
13.45% |
9.72% |
3 year annualised volatility |
9.86% |
17.18% |
10.03% |
3 year Sharpe ratio (RFR = 1%) |
0.97 |
0.73 |
0.87 |
5 year annualised return |
10.03% |
12.56% |
9.49% |
5 year annualised volatility |
7.85% |
13.97% |
7.99% |
5 year Sharpe ratio (RFR = 1%) |
1.15 |
0.83 |
1.06 |
10 year annualised return |
7.50% |
8.12% |
6.86% |
10 year annualised volatility |
7.13% |
13.54% |
7.19% |
10 year Sharpe ratio (RFR = 1%) |
0.91 |
0.53 |
0.81 |
Source: Eurekahedge
Table 1 summarises the key performance statistics for the Eurekahedge ESG Fund Index relative to comparable benchmarks. Key takeaways include:
- ESG compliant funds in the Eurekahedge database have outperformed their non-ESG peers in terms of annualised return over the last three-, five- and ten-year periods (10.59%, 10.03% and 7.50%), supported by their relatively stronger performance compared to their peers in recent years.
- Supported by their lower annualised volatilities, ESG fund managers outperformed their non-ESG peers and the underlying equity market in terms of risk-adjusted returns by posting a higher Sharpe ratio over the last three-, five- and ten-year periods (0.97, 1.15 and 0.91).
Table 2 provides the correlation values between the performance of ESG fund managers against the benchmark indices and non-ESG equity fund managers. ESG compliant funds displayed a strong correlation against both the MSCI ACWI ESG Leaders Index and the Eurekahedge Equity ex-ESG Fund Index.
Table 2a: Correlation matrix
Source: Eurekahedge
Figure 2a and Figure 2b below offer important insights into understanding the return drivers for the Eurekahedge ESG Fund Index. The first chart depicts the performance attribution for quarterly returns by regional mandate, whilst the second chart accomplishes the same by strategy.
With reference to Figure 2a below, the constituents of the Eurekahedge ESG Fund Index are sorted based on their regional exposure into three buckets: developed markets focus, emerging markets focus or a global mandate that spans across both. As the chart below reveals at a glance, emerging markets mandated ESG funds feature heavily in the current index constituent base and have been the major factor influencing returns both on the upside as well as the downside. The implementation of ESG frameworks especially in marketing emerging market mandated funds to sophisticated overseas investors could potentially help add to the appeal for such funds especially in relation to themes such as sound corporate governance and social responsibility. On the other hand, it is worth noting that in the recent quarters after the market meltdown in Q1 2020 following the COVID-19 outbreak, ESG funds staged a strong comeback with two positive double-digit quarterly returns over the last five quarters.
Figure 2a: ESG Fund performance attribution by regional mandate
Figure 2b below provides the breakdown of the ESG index performance and divides the index constituents into two categories: hedge fund strategies and long-only absolute return strategies. As is evident below, funds utilising long-only absolute return strategies are key drivers of returns among the constituents of the Eurekahedge ESG Fund Index, indicating the tilt towards emerging market mandated long-only absolute return strategies within the ESG fund space. However, seemingly contradictory to this observation, roughly 75% of the current Eurekahedge ESG Fund Index utilised hedged strategies. This could be explained by the higher magnitude of the returns of long-only absolute return funds, driven by their higher volatilities compared to hedged strategies which employ short positions to reduce exposure against the equity markets.
Figure 2b: ESG fund performance attribution by strategic mandate
Figure 3 shows the 12-month rolling Alpha of ESG funds against the underlying equity market as represented by the MSCI ACWI ESG Leaders Index. ESG funds have generated an excess return against the MSCI ACWI Leaders Index about 70% of the time, particularly from August 2012 up to August 2018 where the ESG funds consistently delivered a positive alpha against the underlying equity market.
Figure 3: 12-month rolling Alpha of ESG funds vs. MSCI ACWI ESG Leaders Index (RFR = 0%)
The chart below shows the annual performance distribution of ESG funds over the last seven years. In 2020, despite the unprecedented market meltdown in the earlier months of the year, the top 10% ESG fund managers posted an average return of 39.44% - their best performance since 2015. It is also worth noting that in five out of seven years, the top 10% funds generated an average return of at least 20%, while the bottom 10% only incurred losses of not greater than 10%. In addition, the median return of ESG fund managers consistently lie in positive territory except in 2018.
Figure 4: Annual performance distribution of ESG funds
In conclusion, even though the Eurekahedge ESG Fund Index has generated an annualised return that is lower than their non-ESG peers since 2007, ESG funds have managed to generate positive alpha against the MSCI ACWI ESG Leaders Index about 70% of the time. Given the increased awareness of ESG considerations in recent years among investors, it is vital for hedge fund managers to incorporate ESG considerations into their investment decisions. A well-designed ESG framework will allow hedge fund managers to expand their potential investor base and thereby raise more capital in the process. The positive effects of a broader investor base is likely to outweigh the negative impact of the additional compliance burden on funds that incorporate ESG frameworks in their investment process. This will also help to ensure that hedge fund managers do not inadvertently alienate investors that want to ensure that their funds are invested in an ethical manner. In addition, the median return of ESG fund managers consistently lie in positive territory, with 2018 being the only exception.
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