UK equity funds are outperforming their peers and industry rivals when it comes to their overall ESG scores, research has revealed.
Published today, the 2021 FE fundinfo ESG Market Review, which aims to provide investors with a snapshot of how the UK funds industry stacks up in terms of ESG, ethical and impact factors, finds the average UK equity strategy had a score of 8.60 based on MSCI’s ratings process. This is around two points higher than those with a global (6.88) or regional focus (6.46). For emerging market equities, the average fund had an ESG score of just 5.55. Scoring is recorded on a 0-10 scale.
The overwhelming majority of UK equity funds meanwhile – 97.7% of those assessed in the report – were also classed as ‘ESG leaders’ under MSCI’s methodology. Less than 40% of global and regional funds were given this rating, and only 4% of emerging market portfolios.
Awareness of ESG factors has been growing amongst investors in recent years and is increasingly shaping their outlook and governing their decisions. The 2021 FE fundinfo ESG Market Review then is published at an opportune time for investors in allowing them to understand how the UK funds landscape is addressing the challenge of responsible investing.
Oliver Oehri, Co-Head of the ESG Product Group at FE fundinfo
Strong UK governance
Underpinning the performance of UK equity funds’ ESG scores is a trend for strong governance within UK companies. When governance – the ‘G’ in ‘ESG’ investing – was taken into consideration alone, the average score for UK funds stood at 6.42. This compares with 5.11 for global funds and just 4.83 for regional funds. Additionally, of the 16 equity fund sectors covered by this research, the three UK peer groups – IA UK Smaller Companies, IA UK Equity Income and IA UK All Companies – held the highest average governance scores, followed by IA European Smaller Companies, IA Europe Including UK and IA Europe Excluding UK.
Environment
However, UK equity funds are falling behind when it comes to the environmental and social elements of ESG, where they are underperforming global and regional portfolios on both measures. UK funds were also narrowly beaten by emerging market strategies in the social factor. FE fundinfo’s data suggests the European equity sectors were the areas with the highest environmental and social scores, on an average basis at least, while funds with a global remit also performed well on both these measures.
Controversial sectors and businesses
The research also considered a fund’s exposure to businesses and sectors deemed as ‘controversial’, including industries such as alcohol, tobacco and munitions. While funds in the UK equity category achieved the highest average ESG scores overall, the report shows they also tend to have greater exposure to morally ‘controversial’ stocks than other sub-groupings.
Around 60% of UK equity funds own businesses that derive at least 5% of revenues from alcohol, while more than half owned companies that make weapon-system components. Meanwhile, around two-fifths had links to nuclear power, gambling or genetically modified organisms. Some groupings had more exposure than others: three-quarters of UK funds held companies that make weapon-system components, 72.2% of emerging market strategies held firms making or selling alcoholic beverages and half of global funds were exposed to nuclear power, for example.
The report offers some interesting and sometimes surprising insight, and the often counterintuitive results are an important reminder of the inherent difficulty of categorising, comparing and rating ESG funds. For many investors it may come as a shock for example to find funds with large holdings in weapons manufacturers or gambling companies scoring so highly, yet when governance factors are taken into consideration these companies are often better run than others in less controversial industries. It is important to remember that ‘ESG’ and ‘ethical investing’ are not synonymous and the report is a timely reminder of the need for investors to carry out their own in-depth research when it comes to aligning their principles with their investments.
Oliver Oehri, Co-Head of the ESG Product Group at FE fundinfo