Is ESG Enthusiasm Fading?

Ruth Saldanha: After last quarter's blockbuster assets in sustainable products, this quarter seems a bit muted. Does this mean that enthusiasm for ESG is fading? Well, we don't think so. Morningstar Canada's Director of Investment Research, Ian Tam, is here today to talk the numbers.

Ian, thank you so much for being here today.

Ian Tam: Thanks for having me, Ruth. It's great to be here.

Saldanha: Well, now, after Q2 numbers Q3 seems a bit muted. Is this the case, and if so, why?

Tam: Yeah, a great question, Ruth. If you look at the growth in assets first of all, the Q3 growth rate does seem a little bit muted compared to Q2, but the growth in assets considers two things. So, you have to remember that it considers both the performance of the funds as well as net inflows or people purchasing sustainable funds. So, given that the market performance, not just for sustainable funds but all funds, has been fairly lackluster over Q3, especially when you consider the great performance over essentially the post-pandemic rally, it's not really a surprise that assets haven't grown as quickly as in prior quarters. But when you isolate net inflows into sustainable funds over Q3, you'll see that they're fairly close to Q2, so about CAD$2.2 billion in net inflows, which is again, is very comparable to prior quarters.

Saldanha: Now, the first thing you mentioned was performance. So, let's talk about performance for a bit. Over the first three quarters of the year, less than half of the sustainable funds outperformed their category peers. So, is past performance a good place to begin research into these products at all?

Tam: Past performance I think would be a reasonable starting point for additional research. And a very easy way to do that, of course, is to look at the Morningstar Star Rating or the Morningstar rating for funds, which is again the risk-adjusted return after fees compared to the category average. But that being said, if you're an investor that's looking to invest sustainably, it's very likely that performance really isn't the only thing that you're considering.

So, with that in mind, the first thing you want to think about is what approach you would require from a fund or an ETF when investing sustainably. And one of the fallacies of the whole sustainable investment landscape is that the concept of ESG is kind of being used in broad strokes across all different funds, so it's either ESG or not ESG. And it's important to know that there are some very detailed nuances when investing sustainably. There are certainly many funds in Canada that use ESG integration as one of their approaches, but there are also funds that we consider impact funds or those that seek to make a measurable impact in areas like the reduction of fossil fuels or the increase in diversity amongst boards in Canadian companies. And there are also funds that invest broadly in an environmental sector, for example, clean energy. So, these are all very specific approaches, and a fund can use more than one approach. So, as an investor, it's important to understand what you're looking for to avoid any sort of surprises in terms of holdings that you see later on.

So, a good way to start that research process is to consider the Morningstar sustainable attributes framework, which is where our analysts will go in and look at the fund prospectuses, which are regulated and try to pick out how the fund is approaching their sustainable investment strategy.

Saldanha: Now, another way investors could possibly understand this better is through the Canada Securities Administrators new plan to require Canadian issuers to disclose more. What are some of the new requirements likely to be, and what will all of this mean for investors?

Tam: Yeah, it's a great question. There are two main requirements that the CSA is proposing. One is that Canadian issuers disclose their greenhouse gas emissions, so Scope 1, 2 and 3 emissions, as well as how the board plans to manage climate-related risk as well as opportunities. So, the proposal is for a, what they call, a comply or explain framework, meaning that if you're an issuer of Canadian stock in Canada, you have to disclose this information or essentially explain why it is that you haven't disclosed that information.

Saldanha: And what will all of this mean for investors?

Tam: I think, in general, more transparency is always better for investors and specifically, as it comes to this proposal, it will allow investors to make better informed decisions in terms of climate-related risk. And I think a ripple effect of this is there will be additional managed products or funds and ETFs that will focus on Canadian equities. Right now, when you look across the sustainable fund landscape, there are far larger number of sustainable funds and ETFs that have a global equity mandate and far fewer that have a Canadian equity mandate, which is important because Canadians tend to have a very heavy home country bias. So, because right now there's very little information coming from Canadian issuers, when this becomes a requirement or a reporting requirement, I think that will give additional ammunition for fund companies to create products around Canadian equities specifically.

Saldanha: So, a lot going on in this space. Thank you so much for being here today, Ian.

Tam: Thanks, Ruth.

Saldanha: For Morningstar, I'm Ruth Saldanha.