Published on August 14th, 2020 📆 | 3218 Views ⚑0
Funds branded ‘ESG’ are laden with technology stocks
Investment funds branded as “sustainable” are under fire for their heavy exposures to US tech giants at the centre of controversies over data privacy, labour practices and monopolistic behaviour.
Interest in sustainable investing — where funds are supposed to steer money towards companies with strong environmental, social or corporate governance standards — has grown this year, with global assets in such funds reaching $1tn, according to Morningstar, the data provider. Analysts have lauded solid returns for managers pursuing ESG mandates, suggesting good business practices are a contributing factor.
But there is another force at play: ownership of tech stocks that have soared in recent years — and especially during the Covid-19 crisis.
In the year to July 27, eight of the 10 best performing large-cap US funds that incorporated ESG metrics as a key part of their selection process had either Apple, Amazon or Microsoft as their biggest holding, according to Morningstar data.
On average, 17 per cent of those 10 funds’ portfolios are in so-called Faang stocks — a grouping that includes Facebook, Amazon, Apple, Netflix and Google’s parent Alphabet — or Microsoft. That compares with an average exposure of 23 per cent to the tech sector among large-cap US equity funds.
“The man on the street would definitely be surprised about those companies’ inclusion in ESG funds,” said Wolfgang Kuhn, director of financial sector strategies at ShareAction, a responsible investment charity.
Facebook, for example, has drawn criticism over data privacy and misinformation on its platform. But it is one of the 10 largest holdings in Nuveen’s $84m “socially aware” US fund, accounting for 4.5 per cent at the end of June. It is also a big part of Vanguard’s $7.9bn “social index” fund, which tracks the FTSE4Good US Select Index, accounting for 2.4 per cent at the halfway mark this year.
Separate data provided by Refinitiv found that, for the top 10 performing funds that it labels ESG in the year to June 30, 19 per cent of assets were in Faang stocks or Microsoft. That compares with an average 20 per cent exposure to tech sector stocks across all US equity funds.
Refinitiv defines ESG funds more broadly than Morningstar, including those that use ESG screenings as part of their selection process but in a more limited way.
Emre Tiftik, director of sustainability research at the Institute of International Finance, said a bias towards tech stocks was to be expected, because they accounted for a rising share of the market and ESG fund managers “don’t want to be too extreme” in their selections. Strong financials as well as green credentials were important, he said.
But Lauren Peacock, a campaign manager at ShareAction, said there was a risk that “tech is becoming the new oil and gas — investors don’t want to rock the boat when the returns are so good”.
The tech-heavy Nasdaq 100 stock index has risen 28 per cent since the turn of the year, compared with a 4 per cent rise in the benchmark S&P 500.
Seventy-eight per cent of ESG equity indices outperformed non-ESG peers so far in 2020, according to IIF figures. Analysts also note that ESG funds have benefited from low exposures to the energy sector, which was hit hard in the Covid crisis.
Not all fund managers have piled in. EdenTree, a London-based sustainable investment specialist, has rejected Facebook from its ESG-screened funds based on “multiple challenges over data security . . . poor corporate governance and weak business ethics”. It has also deemed Apple unsuitable, mostly because of working conditions at factories in China.
EdenTree said it invested in Alphabet, because the company appeared prepared to listen to people’s concerns and make meaningful changes. Its ESG funds also own Microsoft, which pledged last year to become “carbon negative” by 2030, offsetting all the emissions made since it was founded.
Stephan Petersen, co-manager of Nuveen’s “socially aware” fund, said “having a seat at the table is the best way to influence corporate behaviour”. Fund manager Vanguard said it was “compelled to hold the securities listed in the underlying benchmark index” and was actively engaging with portfolio companies on climate risk.
Amazon declined to comment while Apple pointed to its supplier responsibility report, which said it put “people first in everything we do”. Facebook said it “recognises the importance of sound ESG practices” and was committed to engaging with stakeholders to “continually evaluate the efficacy of these efforts”.
It was crucial that ESG fund managers were transparent about their inclusion criteria, and that they actively engaged with investee companies, said Toby Belsom, director of investment practices at the UN Principles for Responsible Investment.
But that is not always straightforward. Facebook’s dual-class share ownership structure, for example, gives chief executive Mark Zuckerberg majority voting power. “The shareholder structure erodes any influence you might have — unless you’re in the C-suite,” said Tom Fitzgerald, fund manager at EdenTree.