Although responsible investment (RI) had been steadily increasing in popularity for over a decade, it was not until roughly five years ago, in 2018, that it really gained traction with the investing public. In June 2019 105 RI mutual funds and ETFs were on offer in the Canadian market. Since that time, the number of RI funds has tripled, with 307 funds available as of June 2023. But not all funds use the same RI styles or approaches. Far from it.
Throughout this period the number of funds using an RI approach has increased, but the mix of approaches has changed significantly. Chart 1 depicts the percentage of funds using each of the six Canadian Investment Funds Standards Committee (CIFSC) RI Identification Framework approaches over five years.
ESG Integration and ESG Exclusion
Environmental, Social and Governance (ESG) Integration and Evaluation, as well as ESG Exclusion, are the two most common approaches used by RI funds. They are often used as a basis for ensuring a certain level of adherence to ESG principles across an entire investment strategy.
Funds employing an ESG Integration approach have remained relatively constant at 80%, making it the most widely followed RI strategy. Interestingly, ESG Exclusion was initially used by over 90% of funds but has since declined to only 75%. One explanation for this decrease is due to the rise in popularity of ESG Thematic Investing, where excluding specific industries may be unnecessary.
NBI Sustainable Canadian Equity ETF (TSX: NSCE) stands out as a top-performing fund, employing both integration and exclusion approaches, with a 3-year average annual compounded rate of return of over 13%. Another notable fund using integration and exclusion is Franklin Martin Currie Sustainable Global Equity Fund, which achieved a Sharpe ratio of 0.96 in its inaugural year.
ESG Thematic and ESG Best in Class
ESG Thematic Investing is an approach that has seen one of the higher rates of growth, increasing by 50% since 2018 and now representing 30% of all RI investment funds. The rise is attributed to the increased popularity of clean energy and climate themes, which constitute over half of thematic funds.
ESG Best in Class has also experienced significant growth. Over 40% of funds use best in class as part of their portfolio selection process, up from just 25% in 2018. Positive screening is seeing greater use as more RI funds are implementing thresholds to select investments with above-average ESG characteristics.
Mackenzie Greenchip Global Environmental All Cap Fund follows a thematic approach and is one of the standout RI funds with a 4-year Sharpe Ratio of 0.91. Similarly, Horizons Global Sustainability Leaders Index ETF (TSX: ETHI) follows both best in class and thematic approaches, delivering a 4-year average annual compounded rate of return of 13%.
ESG Related Engagement and Stewardship Activities
The only approach besides ESG Exclusion to decline significantly is ESG Related Engagement and Stewardship Activities. While over 50% of funds used this approach in 2018, that number has decreased to less than 30% today. This is not to say that firms have ceased engagement; rather, that new funds are less likely to adopt it as an RI approach than in the past. Several reasons contribute to this decline, including pressure from regulators to document and make policies, meeting, and voting records available.
Desjardins SocieTerra American Equity Fund is one of the best-performing engagement funds, having received a Fundata A+ Award in 2022. Manager ClearBridge Investments maintains engagement and proxy voting records for investors to verify.
Impact Investing
Although it appears to be a minor increase on the graph, Impact Investing has undergone the most significant change of any RI approach. Since 2018, it has nearly tripled from just 3.5% of funds to over 10% today. This change is primarily due to the greater number of environmental funds and, especially, dedicated impact bond funds. With no impact bond funds five years ago, they now account for almost half of all RI funds using this approach. Impact funds possess the unique ability to make investments that are positioned to have a direct impact on the world around them.
Historically, this has been the most challenging RI approach to implement and monitor, but the UN PRI notes that “impact investing has shifted from a disruptive investment concept to a complex and rich investment ecosystem.”
Top-performing funds using an Impact Investing approach include NEI Environmental Leaders Fund with a 5-year average annual compounded rate of return of 7.4%, and CI MSCI World ESG Impact Index ETF (NEO: CESG) with a 3-year Sharpe Ratio of 0.70.
One thing is for certain: As ESG goals and Canadian investor preferences continue to evolve, rapidly-changing RI fund methodologies offer investors a widely-varied menu of styles and performance outcomes. All the more reason to drill down into the performance and risk data when making comparisons and selecting funds for investment.