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The future of ESG thematic funds

Two young intercultural workers of vertical farm in protective workwear standing in aisle by shelves with green lettuce seedlings during work
Two young intercultural workers of vertical farm in protective workwear standing in aisle by shelves with green lettuce seedlings during work

Specialist funds that seek to target a specific environmental, social or governance issue are growing in popularity in the investor community 

Last month, Credit Suisse announced that it had partnered with JP Morgan Asset Management to launch a sustainable nutrition fund that will invest in companies addressing the links between nutrition, health, biodiversity and climate. 

With an initial $250m investment, the fund seeks to target the UN sustainable development goals of zero-hunger climate action. 

The fund will prioritise companies that make food systems less carbon intensive. This includes allocations to vertical farming, plant-based proteins and food testing.

Steven Bates, head of investment products and selection at Credit Suisse, says the fund will “have a strong focus towards smaller capitalisation and aim to identify the companies that are truly shaping the future of nutrition, while at the same time identifying businesses that might become strong targets for acquisition by larger players.”

This is not the only fund available to invest in a particular sector; there are several funds available that have a sustainable or social focus area, including water management, clean energy and gender equality. 

Creating a fund

Bates says that designing a fund with such a specific brief is a long-term task that requires broad effort. He says: “Numerous stakeholders across fund selection, sustainability and product specialists are involved in tailoring the requirements.”

Active management plays a key role in identifying a relevant subset of companies that fulfil the manager’s criteria in multiple dimensions, he notes: “First and foremost matching to the theme, but also in terms of ESG ratings of companies, valuations and portfolio composition, and engageability.” 

Bates explains that while a thematic trend such as nutrition is present across many topics and companies, it is important to be selective and build a targeted exposure.

If that is the case, how difficult is it to select companies for a thematic fund? Simon Hallett, a partner at investment firm Cambridge Associates, says that for quite narrow or specific themes “it can be hard to express them through publicly listed stocks without either making the link with the theme implausibly tenuous, or else finding stocks with only a minority of their business aligned with the chosen theme”. 

He explains that it depends on the theme — if it is too narrow, the EU’s Ucits diversification requirements may allow less well-aligned investments be included.

However, private managers looking at smaller, more focused businesses may find it easier to get pure exposure to the theme. They have the “additional level of control and can, in some cases, ‘make the theme happen’ through requiring portfolio companies to take action to improve resource efficiency, for example”, he says.

Securing good returns

Though thematic funds have the altruistic aim of aiding a particular problem in society, their predominant purpose is to provide strong returns for investors. The question is whether performance be sacrificed in favour of being overly selective.

Hallett says that it is difficult to ensure good returns for any kind of fund. “A key distinction is between, on the one hand, managers who have genuine domain expertise and skills beyond simply financial and — on the other — funds opportunistically constructed to meet market demand and where the manager is performing little more than a high-level screening exercise.”

He also points out that fundamental themes, especially those related to ESG, are often based on changes that will only pan out over a horizon of several years. 

Hallett says: “Short-term performance against the broad market will be meaningless, but it requires conviction and discipline to hold on for long enough to prove the thesis.”

However, for private markets specifically, Hallett says data from Cambridge Associates shows that sector funds perform better than generalist funds and so “domain expertise pays off”.

Furthermore, he considers that funds where ESG is genuinely integrated into the investment decision-making process, as opposed to being applied as an ex-post filter, can gain some advantage by incorporating long-term fundamental information that shorter term investors with a narrow focus in the financials may miss.

Future of thematic funds

A survey conducted by Greenwich Associates and sponsored by BNP Paribas Asset Management finds that investor appetite for thematic funds has grown significantly over the past year

This structural change highlights a fundamental shift in approach to asset allocation, away from a focus on asset class, geography and business sector, and towards a more thematic approach.

For 76 per cent of investors surveyed, the main goals of thematic investing strategies are sustainability and ESG, followed by the ability to enhance investment returns, including a more innovative or disruptive investment approach, or increasing diversification. 

Additionally, 90 per cent of investors surveyed believe that thematic investing has a positive impact on long-term performance.

Bates says that the asset manager will continue to look for opportunities that align with its overall investment themes, adding: “We believe it is important to invest with purpose to make an impact and seek attractive returns for clients”. 

Hallett notes that it is possible that the popularity of thematic ESG funds will continue to rise. He says: “If you believe, as we do, that the path of transition to a low-carbon economy may be the biggest single driver of relative investing returns over the next two decades, then thematic investing has a place in responding to that.”

However, he adds that caution is needed as the investment industry has a long history of “promoting ‘concept’ strategies that are more popular with the marketing department than the investors”.

A service from the Financial Times