Hundreds of conventional funds add 'ESG' to prospectus just in case

Trend is seen as part marketing and part endorsement of ESG's investment benefits

Aug 1, 2019 @ 2:38 pm

By Jeff Benjamin

If the evolving language inside mutual fund prospectuses is a guide, financial advisers should brace for an expanding selection of funds focused on environmental, social and corporate governance issues.

The record $8.9 billion of net inflows into ESG-strategy funds through the first six months of this year illustrates the ferocious demand for funds that are aimed at an increasingly conscious investor base, led by millennials and women.

The midyear net flows, as tracked by Morningstar, compare to $5.5 billion for all of 2018.

This growing appetite has not been lost on the mutual fund industry, which has been quietly updating fund prospectuses with language suggesting potential ESG portfolio management considerations.

According to Morningstar, the prospectuses of more than 100 "conventional funds" have added ESG criteria since the start of the year, nearly doubling the total number of non-ESG fund prospectuses that now sport such language.

Jon Hale, Morningstar's global head of sustainability research, refers to this unique subgroup of funds adding ESG language as "ESG consideration funds," because that's essentially what the management appears to be saying.

"These funds are not being repurposed into ESG funds, but they have added language to the prospectus to say they are considering it, and then they sort of leave it at that," Mr. Hale said. "If anything further is included, it might be a caveat that explains ESG doesn't necessarily drive all the investment decisions."

Conventional funds that have added ESG language run the gamut from the $13.2 million Aberdeen China Equity (GOPIX) to the $113 million BNY Mellon Global Dynamic Bond (DGDYX), $307 million Hartford MidCap Value (HMVIX), $6.2 billion JPMorgan Emerging Markets Equity (JEMSX) and the $247 million Neuberger Berman Floating Rate Income (NFIAX).

Cynics might assume these prospectus tweaks are grounded in marketing. But even though some analysts acknowledge that as a possibility, they also recognize that only a small fraction of investors read fund prospectuses.

Daniel E. Ingram, vice president of responsible investment and consulting at Wilshire Associates, believes the trend is about preparing for growing investor demand for ESG strategies as well as helping funds pass the screens of institutional investors that are starting to add mandates for ESG criteria.

"I'm guessing that this is placeholder language while they're trying to gauge how persistent the demand is, and it gives fund managers latitude to integrate further down the line," he said. "Skeptically, I would ask, 'What are you waiting for?'"

Todd Rosenbluth, director of mutual fund and ETF research at CFRA, speculates that the changes in prospectus language are driven by a combination of marketing and investment performance.

"Advisers and investors are increasingly looking for ESG funds to round out the lineup," he said. "ESG is being incorporated more and more alongside other balance sheet factors."

Anita Baldwin, head of research at Hartford Funds, said her company added the prospectus language to funds this year because of the potential to leverage the expertise of Wellington Management and Schroders, which subadvise some ESG funds for Hartford.

"A majority of our funds are subadvised by Wellington and Schroders and as a result all of our funds have the benefit of the investment management and research, so we felt it was appropriate to include it in prospectuses," she said. "There are also platforms where those ESG distinctions are considered."

Mike Hunstad, head of quantitative strategies at Northern Trust Asset Management, said the trend of conventional funds adding ESG considerations is the latest example of the asset management industry recognizing the alpha potential of ESG investing.

"I think ESG investing will become increasingly mainstream in the U.S, just like it is elsewhere," he said. "It's becoming more and more clear that ESG can be used as an alpha source, which means we should be using it in portfolio construction."

Of the more than $900 billion under management at Northern Trust, Mr. Hunstad said about $88 billion is invested in strategies that apply a variation of ESG screens, and more than $7 billion is invested in strategies where ESG is designed to be the source of alpha.

(More: Disruptive ETFs face an ESG disruption)

Morningstar evaluates funds with a global sustainability rating that is based on each fund's underlying holdings.

Perhaps not surprisingly, the funds that are described as ESG-focused tend to score highest on the sustainability scale. But what is more interesting is that funds that cite ESG considerations in their prospectuses generally earn higher sustainability scores than funds overall, Mr. Hale said.

"It's hard to deny there isn't a marketing element to it, and this is a way to address it without having to launch dedicated strategies and products," he said. "But there's also the alpha factor to consider."

(More: Register now for InvestmentNews' inaugural ESG & Impact Forum on Dec. 5 at the United Nations)


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