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Ethical funds are booming but there are obstacles to momentum

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It looks as if 2020 will be another year of outperformance for ESG funds — those focused on investments with a positive environmental (E) or social (S) impact, and companies with a record of good governance (G). Some conclude that we are in the early stages of a “momentum trade” that favours sustainable investments.

Philipp Hildebrand, former head of the Swiss central bank and now vice-chairman of investment manager BlackRock, predicted as much at the start of the year when he said the huge quantities of money coming into ESG funds would push up the prices of the investments they own. The message: Get in now while the ESG train is still picking up steam.

It is a seductive idea, especially in an era when longtime activist investors such as Chris Hohn in the UK and Jeff Ubben in the US have shifted their focus to the area. Hohn has been pressing companies to do more to tackle climate change, while Ubben, who left his hedge fund ValueAct to found a new ESG-focused asset manager, is sniffing the wind.

Money invested in ESG funds jumped from barely $300bn in 2011 to close to $900bn last year, says BlackRock, citing IMF data. Morningstar pegged the $1tn milestone as having been passed in the second quarter of 2020.

In Europe, where regulators are giving the movement a push, ESG funds could outnumber traditional funds as soon as 2025, according to one startling prediction from PwC. Could this mean the outperformance of ESG funds is preordained? Morningstar, tracking such funds in the US, found that in every year since 2015, a majority beat their respective markets. That was the case again in the first nine months of this year. ESG funds tend to be focused on the tech sector, which has been the big winner this year, but that does not seem to fully explain the outperformance.

According to a study by the World Resources Institute, a Washington think-tank, the stocks that are picked by ESG funds seem to be beating the market, raising the prospect that Hildebrand’s predicted “sustainability premia” are creeping into share prices. There are problems with this theory, and not just that, with equity markets worth $70tn globally and about $130tn in bonds, it is too early to expect ESG fund inflows to be large enough to move markets.

A momentum trade in ESG stocks, where investors buy shares they think will continue rising, seems unlikely while there is such disagreement over what constitutes an ESG investment. In this respect, matters are getting worse. As the number of funds has risen, so too has the number of indices and scoring systems purporting to identify companies with positive, or relatively positive, ESG performance. A study this year by academics in Geneva found very little correlation between stocks favoured by different environmental and social ratings providers (and basically no correlation at all between those given high governance scores).

You know things are bad when there is a Twitter account parodying the standards setters. “My standards bring all the boys to the yard. And they’re like, it’s better than yours,” reads a tweet from @makeESGgreat.

Wildly complex or subjective rules can lead to a lot of chopping and changing even within an ESG index, further disrupting the possibility of a momentum trade. The S&P 500 ESG index is trying to maintain a sectoral balance similar to the wider market, as well as weighting for ESG scores, and it also reviews corporate “controversies” — such as a labour dispute or a human rights issue that appears in the news — after which a stock may be kicked out for a year. It eliminated thermal coal producers recently, adding them to the list of no-go sectors along with tobacco and some weapons manufacturers.

That leads to a third problem for an ESG momentum trade. If the cancel culture that did for thermal coal takes out other constituents, funds may end up missing out on some of the investments that could drive their returns the most. Ubben at least is trying to avoid that, by explicitly planning to consider companies in fossil fuels and for-profit education, for example. “By virtue of being incumbents and thus being perceived as part of the problem, so-called ‘legacy’ companies show the greatest potential to become part of the solution and to be revalued,” his firm’s mission statement says.

None of which is to say aligning an investment portfolio with your social and environmental goals is not a good idea. Just don’t expect the momentum behind ESG investing to put any more wind behind your sails.

Stephen is reading . . . 

Invisible Man by Ralph Ellison. Having recently become a US citizen, I’m catching up on my American literary classics. Nearly 70 years after it was published, this examination of racism and its effects on identity could not be more relevant today.

Follow Stephen on Twitter @StephenFoley

This article is part of FT Wealth, a section providing in-depth coverage of philanthropy, entrepreneurs, family offices, as well as alternative and impact investment





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US regulators launch crackdown on Chinese listings

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US financial regulation updates

China-based companies will have to disclose more about their structure and contacts with the Chinese government before listing in the US, the Securities and Exchange Commission said on Friday.

Gary Gensler, the chair of the US corporate and markets regulator, has asked staff to ensure greater transparency from Chinese companies following the controversy surrounding the public offering by the Chinese ride-hailing group Didi Chuxing.

“I have asked staff to seek certain disclosures from offshore issuers associated with China-based operating companies before their registration statements will be declared effective,” Gensler said in a statement.

He added: “I believe these changes will enhance the overall quality of disclosure in registration statements of offshore issuers that have affiliations with China-based operating companies.”

The SEC’s new rules were triggered by Beijing’s announcement earlier this month that it would tighten restrictions on overseas listings, including stricter rules on what happens to the data held by those companies.

The Chinese internet regulator specifically accused Didi, which had raised $4bn with a New York flotation just days earlier, of violating personal data laws, and ordered for its app to be removed from the Chinese app store.

Beijing’s crackdown spooked US investors, sending the company’s shares tumbling almost 50 per cent in recent weeks. They have rallied slightly in the past week, however, jumping 15 per cent in the past two days based on reports that the company is considering going private again just weeks after listing.

The controversy has prompted questions over whether Didi had told investors enough either about the regulatory risks it faced in China, and specifically about its frequent contacts with Chinese regulators in the run-up to the New York offering.

Several US law firms have now filed class action lawsuits against the company on behalf of shareholders, while two members of the Senate banking committee have called for the SEC to investigate the company.

The SEC has not said whether it is undertaking an investigation or intends to do so. However, its new rules unveiled on Friday would require companies to be clearer about the way in which their offerings are structured. Many China-based companies, including Didi, avoid Chinese restrictions on foreign listings by selling their shares via an offshore shell company.

Gensler said on Friday such companies should clearly distinguish what the shell company does from what the China-based operating company does, as well as the exact financial relationship between the two.

“I worry that average investors may not realise that they hold stock in a shell company rather than a China-based operating company,” he said.

He added that companies should say whether they had received or were denied permission from Chinese authorities to list in the US, including whether any initial approval had then be rescinded.

And they will also have to spell out that they could be delisted if they do not allow the US Public Companies Accounting Oversight Board to inspect their accountants three years after listing.



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Wall Street stocks climb as traders look past weak growth data

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Equities updates

Stocks on Wall Street rose on Thursday despite weaker than expected US growth data that cemented expectations that the Federal Reserve would maintain its pandemic-era stimulus that has supported financial markets for a year and a half.

The moves followed data showing US gross domestic product grew at an annualised rate of 6.5 per cent in the second quarter, missing the 8.5 per cent rise expected by economists polled by Reuters.

The S&P 500, the blue-chip US share index, closed 0.4 per cent higher after hitting a high on Monday. The tech-heavy Nasdaq Composite index climbed 0.1 per cent, rebounding slightly after notching its worst day in two and a half months earlier in the week.

The dollar index, which measures the US currency against those of peers, fell 0.4 per cent to its weakest level since late June after the GDP numbers.

“Sentiment about the economy has become less optimistic, but that is good for equities, strangely enough,” said Nadège Dufossé, head of cross-asset strategy at fund manager Candriam. “It makes central banks less likely to withdraw support.”

Jay Powell, the Fed chair, said on Wednesday that despite “progress” towards the bank’s goals of full employment and 2 per cent average inflation, there was more “ground to cover” ahead of any tapering of its vast bond-buying programme.

“Last night’s [announcement] was pretty unambiguously hawkish,” said Blake Gwinn, rates strategist at RBC, adding that Powell’s upbeat tone on labour market figures signalled that the Fed could begin tapering its $120bn a month of debt purchases as early as the end of this year.

The yield on the 10-year US Treasury bond, which moves inversely to its price, traded flat at 1.26 per cent.

Line chart of Stoxx Europe 600 index showing European stocks close at another record high

Looking beyond the headline GDP number, some analysts said the health of the US economy was stronger than it first appeared.

Growth numbers below the surface showed that consumer spending had surged, “while the negatives in the report were from inventory drawdown, presumably from supply shortages”, said Matt Peron, director of research and portfolio manager at Janus Henderson Investors.

“This implies that the economy, and hence earnings which have also been very strong so far for Q2, will continue for some time,” he added. “The economy is back above pre-pandemic levels, and earnings are sure to follow, which should continue to support equity prices.”

Those upbeat earnings helped propel European stocks to another high on Thursday, with results from Switzerland-based chipmaker STMicroelectronics and the French manufacturer Société Bic helping lift bourses.

The region-wide Stoxx Europe 600 benchmark closed up 0.5 per cent to a new record, while London’s FTSE 100 gained 0.9 per cent and Frankfurt’s Xetra Dax ended the session 0.5 per cent higher.

In Asia, market sentiment was also boosted by a move from Chinese officials to soothe nerves over regulatory clampdowns on the nation’s tech and education sectors.

Beijing officials held a call with global investors, Wall Street banks and Chinese financial groups on Wednesday night in an attempt to calm nerves, as fears spread of a more far-reaching clampdown. Hong Kong’s Hang Seng rose 3.3 per cent on Thursday, although it was still down more than 8 per cent so far this month. The CSI 300 index of mainland Chinese stocks rose 1.9 per cent.

Brent crude, the global oil benchmark, gained 1.4 per cent to $76.09 a barrel.



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Man Group posts tenfold gain in performance fees

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Man Group PLC updates

Man Group, the world’s largest listed hedge fund manager, reported first-half performance fees 10 times higher than a year ago, in the latest sign of the industry’s robust rebound from the coronavirus pandemic.

Strong commodity and equity markets helped take performance fees at the London-based company to $284m in the six months to June, up from $29m a year before when March’s huge market falls hit many fund returns, and the highest level since at least 2015. Performance fee profits were 50 per cent above broker consensus forecasts.

Man also posted $600m of net client inflows in the three months to June, its fourth consecutive quarter of inflows, although the figure was lower than analysts had expected. However, $6bn of investment gains in the second quarter helped lift assets under management to a record high of $135.3bn.

Column chart of Half-yearly performance fees ($) showing Man Group cashes in on market rebound

Man’s results highlight how strongly the $4tn hedge fund industry has bounced back after a turbulent 18 months for markets, including a huge sell-off last spring, as well as sharp market rotations and retail investor-driven rallies in meme stocks that some funds were betting against.

Last year, hedge funds, which have long been criticised for mediocre returns and high fees, made 11.8 per cent on average, according to data group HFR, their best calendar year of gains since 2009 in the wake of the financial crisis.

Investors have taken notice. After three years of net outflows, the industry has posted $18.4bn of inflows in the first half of this year.

Chief financial officer Mark Jones said the hedge fund industry was now benefiting from a tailwind after strong gains last year. “You saw hedge funds deliver exactly what clients wanted,” he told the Financial Times.

“Clients need new sources of return,” he added. They “are trying to reduce their bond exposure, and most have as much equity exposure as they can stomach”.

This year Man has made strong gains at its computer-driven unit Man AHL, named after 1980s founders Mike Adam, David Harding and Martin Lueck, which tracks trends and other patterns in markets.

Its $4.6bn AHL Evolution fund, which bets on trends in close to 800 niche markets, has gained 10.2 per cent so far this year and contributed $129m of the performance fees in the first half. The fund is shut to new money but Jones said that late last year it opened briefly to new investment, raising $1bn in a week.

Man’s first-half profits before tax came in at $323m, well above analysts’ forecasts. The company also said it would buy back a further $100m of shares in addition to the $100m announced last September. Broker Shore Capital said the company had posted “blowout” figures.

Man’s shares rose 2.4 per cent to 196 pence, their highest level in three years.

Last month, Man announced that chief investment officer and industry veteran Sandy Rattray would leave the company. Meanwhile, Jones is set to step down from the board and take on the role of deputy chief executive, overseeing the computer-driven AHL and Numeric units.

laurence.fletcher@ft.com



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