A front-line view of ESG’s indomitable rise

TDAM explains the rapid growth of ESG investing in Canada and why your clients really can do good and potentially earn more on their portfolio

A front-line view of ESG’s indomitable rise

Whether it’s the devastating effect of the global COVID-19 pandemic, Greta Thunberg’s crusade for climate change action or the new wave of green energy initiatives, environmental, social and governance (ESG) issues are hot topics.

The impact of this heightened news coverage and education has been raised awareness among investors, product providers and market makers on both the retail and institutional side. In Canada, according to TD Securities, there is now about $5.3 billion in ESG ETFs - in Q4 of 2020, there was about half that – and this year has already featured the first $1 billion trade.

The rise of ESG is also reflected in the number of ETF products in Canada, which now stands at 62. The first two were launched as recently as 2017. Growth in this space has been exponential – and eye-catching.

But can you really do good and earn more on your portfolio? The answer in 2021 is very clear - most ESG mandates have provided better risk-adjusted returns, compared to similar non-ESG mandates, for clients, according to Jonathan Needham, VP, ETF Distribution – Eastern Canada, TD Asset Management Inc. (TDAM).

TDAM launched three new ESG index strategy ETFs in December: the TD Morningstar ESG Canada Equity Index ETF (TMEC), the TD Morningstar ESG U.S. Equity Index ETF (TMEU), and the TD Morningstar ESG International Equity Index ETF (TMEI).  They are designed for investors seeking a low-cost, differentiated ESG solution and provide similar exposure to the broad market index while investing in best-in-class companies that are driving positive change.

Needham believes that there is now more understanding among investors that ESG does not mean sacrificing growth and returns but could potentially do the opposite.  "Since companies with higher ESG ratings are less prone to controversies, this may help their long-term risk-adjusted returns" Needham adds. 

He said: “As fiduciaries, we look at it from a risk and an opportunities perspective, and you're managing risk by putting an ESG lens on everything you do. I would argue that the proof is in the pudding - you're getting better opportunities and better outcomes for clients.”

As the inflows show, there is a clear demand for companies to do better in terms of the environment and clean energy, as well as addressing key social issues like relations with local and/or indigenous communities, and ensuring diversity in the boardroom.

From a retail perspective, the assumption is that it’s millennials driving ESG investing. However, the growth has been shown to be much broader across demographics and generations. A recent survey by the Responsible Investment Association (RIA) revealed that more than 72% of Canadians are interested in sustainable investing, which remains consistent with findings a year prior.

The research did reveal, though, that younger investors care slightly more, with 83% of those aged 18 to 34 interested in ESG compared to 59% of respondents aged 55+. Needham believes the reason for this tilt is self-sought education. He added: “I've worked with many millennials and they just seem to put more focus on what they put in their bodies and what they're producing in terms of waste, and they're going to do the research to make sure that those companies are doing right.”

Historically, 75% of ESG investors have been institutions, with the pandemic pulling that number down only slightly, according to Andres Rincon, Director, Head of ETF Sales & Strategy at TD Securities.

While ESG funds have been available in North America for more than a decade, it is only recently that these funds have witnessed a huge pick-up in assets. So, what has been the impetus over the past three years for this uptick in inflows?

Rincon said: “There has been a change in mentality of what's important to everybody. We had the Paris Agreement, which has become very relevant over the past few years, plus these trends take time. Carbon emissions, for example, have become more important and many other different players are telling investors about the importance of being green and environmentally friendly.”

He added that an environmental investment lens was visible in earlier mutual funds, while governance has always been part of finance. However, the grim toll of the global pandemic has really brought the social aspect to the forefront.

Areas of growth also include fixed income, where investors are applying a heavier weighting to certain ESG-friendly bond issuers, and asset-allocation ETFs, where it is now possible to purchase a one-ticket ESG solution.

But the huge wave has come through clean energy, carbon neutral or low-carbon ETFs. Rincon called this a mega trend that is here to stay as clean energy transitions into becoming our primary source of energy.

Rincon said: “There’s a reason why Tesla cars are popular. They are not just good-looking cars, they are also very energy efficient. Obviously, you can make an argument about the use of batteries and valuations but everybody's becoming more conscious in terms of how much energy they use and what type of energy they're using. It’s a long-term trend. There’ll be ups and downs with valuations, but I do believe it is something that has a long life.”

Needham agreed and believes that governments’ clean energy mandates, in particular in the U.S., have super-charged interest and inflows.

He said: “Solar and wind were big winners in that space. I would also say that most of these products, whether it's clean energy, solar, wind, hydrogen, and/or broad-based strategies, like we have at TD, are getting immediate acceptance and immediate assets. The new cycle has affected change in a positive way and quickly.”

Since its early days, the ESG market has evolved to a point where there are much fewer exclusionary products on offer, with screening more inclusionary and sophisticated. This shift means you can still be exposed to the traditional market, but with a skew towards ESG-friendly companies.

Rincon explained that most of the metrics are now more complex and we need to understand you just can't take out an entire industry.

“For the most part, many are points-based. Through that, you are able to offer a product to a client that is easier to manage and understand, but also easier to justify if you're just using it for beta.

“The initial push in ETF land is still more passive driven and evolving towards active, so the traditional institutional investor is expecting a more beta-like product.”

This is a trend that advisors can easily adopt for retail investors, said Needham, allowing for ESG integration within the core of your portfolio without dramatically changing client outcomes. That predictability is important when writing financial plans.

He said: “If this trend continues, which I'm confident it will, we probably won't talk about ESG investing in 5-10 years, it'll just be investing because you're getting better outcomes through the lens of ESG screens.”

Visit the TDAM Sustainable Investing website for more information on how TDAM is implementing ESG into their investment process.