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The next breakthrough in ESG investing

What are the next breakthroughs in the development of ESG investing and sustainability in the industry?  Adina Taylor, Investment Product, Nicole Connolly, Head of ESG Investing and Portfolio Manager, and Sarah Pulsifer, Investment Product lead the way.

Interest in environmental, social and governance (ESG) investing continues to grow, with 2018 marking a significant increase in the number of 40-act products now classified as ‘Sustainable’ by Morningstar.

Given the increased attention, product proliferation and ambiguity around what defines ESG, a small group of us gathered to discuss ESG industry trends, how Fidelity is defining ESG and the evolution of ESG within investment product offerings.

What's trending?

Inflows into ESG funds continue to be quite strong, and the pace is accelerating. Our most recent analysis showed a third of inflows over the past five years occurred in 2018.

According to the recently released Morningstar Sustainable Landscape report, sustainable ETFs are approaching parity with open-end funds in the sustainable funds universe.

Over the past three years, the number of new sustainable ETF launches nearly matched those of open-end funds. Sustainable ETF net flows grew to 40% of overall sustainable fund flows in 2018 from 20% over the previous two years.1

Another noteworthy trend in 40-act ESG products has been the repositioning of actively managed funds to ESG funds by a significant number of firms.

Repositioning – at the minimum -- is modifying prospectus language to include a reference or references to ESG. This has notably increased the number of ESG-oriented products and converted a meaningful pool of assets, but it does not necessary reflect organic growth.

"In fact, when surveyed, 86% of Millennials view ESG as a normal and desirable part of any investment portfolio."

It is also important to note that these positive trends have occurred on a small base of assets, with ESG Focused Equity funds representing less than 2% of the total mutual fund and exchange-traded fund (ETF) assets2.

So, why is ESG AUM still so small? Looking across distribution channels, we noted that in Defined Contribution plans, sponsors have focused on consolidating their offerings and emphasizing performance in the plan lineup.

In addition, last spring’s DoL Field Assistance Bulletin emphasized that plan fiduciaries must always put the economic interests of participants first, and that ESG should not take precedence over other factors.

Financial advisors have also been slow to embrace ESG, with survey data suggesting that many believe that a client must sacrifice returns in order to invest in ESG products.

"In Asset Managementwe think of ESG as just another way to evaluate management quality, a company’s business model, innovation, customer satisfaction, and talent retention."

This belief is also held by many retail investors, in particular older, more affluent clients. Younger customers and women express interest in ESG investing, but many of the younger customers are in the early innings of saving and their assets represent a fraction of that of the 60+ age group.

Another factor that could be inhibiting growth of ESG products is the emergence of broader stakeholder expectations, meaning customers expect that asset managers are assessing ESG risks as good stewards of capital.

In fact, when surveyed, 86% of Millennials view ESG as a normal and desirable part of any investment portfolio. In a recent Callan survey of U.S. institutional investors, more than half of all respondents indicated that they consider ESG a factor in every selection decision and that they have communicated to managers that ESG is important.

Thus, clients might not be only focused on dedicated product, but rather on investment managers that incorporate sustainability values in the way they manage money.

This could result in an evolution where existing strategies provide exposure to ESG values, which reduces the need for dedicated investment capabilities.

The Fidelity view on ESG

From a product standpoint, Fidelity views ESG as an umbrella term covering several types of sustainable investing, which ranges from ESG Integration, meaning the systematic integration of ESG considerations, from the standpoint of both risk and opportunity into investment due diligence and financial analysis, to Impact Investing, which is investment in companies with the intention to generate social and environmental impact alongside financial gain.

As a UN PRI signatory, Fidelity embraces its responsibility to align with the Principles by integrating ESG research into our security selection, ensuring our Proxy voting guidelines consider Environmental, Social and Governance issues, and engaging with portfolio companies on ESG issues.

In Asset Management, we continue to commit resources to research ESG risks and opportunities, which are used by our chief investment officers, portfolio managers and analyst teams to make better decisions.

"Interest in environmental, social and governance (ESG) investing continues to grow, with 2018 marking a significant increase in the number of 40-act products now classified as ‘Sustainable’ by Morningstar."

The goal is to embed ESG resources within our investment management processes to ensure our investors can factor in sustainability criteria into the mosaic of their investment theses.

While there are many definitions of ESG, as we in Asset Management incorporate it into our investment process, we believe it’s investing in companies that are cognizant that they live in a world of finite resources and therefore manage their operations in a way to limit their use or impact on those resources.

These are typically companies that subscribe to the notion of stakeholder integration, believing that a company that does well by their customers, suppliers, employees, communities and shareholders will be a more successful company over the long-term.

In Asset Management, we think of ESG as just another way to evaluate management quality, a company’s business model, innovation, customer satisfaction, and talent retention.

We also believe that investing with an ESG lens can help investors avoid the downside that can come through ESG-related controversies.

But we acknowledge that there is a lot more work to be done in ESG education for all types of clients: individual investors, institutional investors and financial advisors.

And, we are committed to delivering education targeted to these different audiences. Our ESG webpage strives to inform customers about how to make meaningful investments, while still helping reach their financial goals.

"Another noteworthy trend in 40-act ESG products has been the repositioning of actively managed funds to ESG funds by a significant number of firms."

For our advisor and institutional clients, we recognize the need for even more transparency. Specifically, how do we help them deepen their understanding of a product’s true ESG profile.

For example, we’ve found that less than 4% of institutional equity ESG strategies that consider ESG in their investment process would be considered ESG-focused.3

And on the retail front, more than 90% of equity mutual funds classified as “Socially Responsible” have a lower ESG portfolio score than that of their respective MSCI ESG Index.4

The future of ESG

There continues to be a growing demand for dedicated ESG products, both actively and passively managed.

In Asset Management we’ve also seen a growing interest in Thematic investing, both for ESG and more broadly, as a way to provide customers the opportunity to invest in alignment with their specific values and interests.

We believe that the trend towards personalization will become more pronounced in financial services, as investors strive to allocate investments towards the targeted areas that are most important to them.

We think impact accountability, meaning how to define and measure and manage impact will be an increasingly important part of the customer experience.

Ultimately, it will be crucial for investment managers to continue to explore what ESG really means to different types of clients and find creative ways to incorporate that into investment product, their broader research and portfolio management practices and in how they communicate with customers.

It’s exciting to think about the future of ESG not only for our firm, but what it will mean for the entire investments industry!

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