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ESG Investing: Momentum Moves Mainstream

2021 brings collective demand for change around the globe.

January 20, 2021

ESG ranked as the top asset class for increased allocations in J.P. Morgan’s U.S. Fixed Income Strategy client survey for 2021. In a recent report, J.P. Morgan Global Research explores the factors that are accelerating ESG investment flows, highlighting the growth of the asset class and new developments including a discussion of the ESG market and index outperformance during COVID-19. J.P. Morgan’s Equity Research team covers ESG trends around the world in 13 sectors, including renewables, autos, transportation, software technology, oil and gas, mining and steel, utilities, telecom, and consumer goods.

“2020 marked a new dawn for ESG as it is now clear that the U.S. will be actively engaged in better integration of long-term sustainability goals that support the prospects for ESG investing. President Biden elevates the ESG agenda and is taking an approach that is both multilateral and multi-dimensional in nature,” notes Joyce Chang, Chair of Global Research.

COVID-19: A Tipping Point for ESG?

COVID-19 is going down in history as one of the most economically destructive events of the past 125 years, a period that includes two World Wars, the Great Depression and the Global Financial Crisis. Its economic toll has put the spotlight on pandemic resiliency and accelerated changes in corporate behavior, highlighting the need to assure public health and safety, as well as the resiliency of supply chains.

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Stakeholders are increasingly pricing in sustainability preferences and we expect a more favorable political and regulatory environment for ESG investing.

Jean-Xavier Hecker
& Hugo Dubourg

Co-Heads of ESG & Sustainability
Research
J.P. Morgan

With the movement for racial justice igniting over the past summer following the death of George Floyd, public and corporate views have rapidly evolved as increased shareholder activism has demanded greater focus on advancing diversity and equity.

The core of incoming President Biden’s “Build Back Better” proposal is a $2 trillion sustainable infrastructure and clean energy plan that aims to achieve a carbon pollution-free power sector by 2035, to produce net zero emissions by 2050, and to reduce by half the carbon footprint of buildings. Beyond the focus on climate change, Biden’s platform includes significant social measures to reform taxation, expand healthcare coverage and forgive student loans.

“2020 will be remembered for putting the spotlight on the ‘S’ and ‘G’ pillars as COVID-19 broadened the focus beyond the ‘E’ factor.

Stakeholders are increasingly pricing in sustainability preferences and we expect a more favorable political and regulatory environment for ESG investing,” note Jean-Xavier Hecker and Hugo Dubourg Co-Heads of ESG & Sustainability Research.

Europe continues to lead in climate change policy, and COVID-19 has increased the ambitions of “green budgets,” which intend to mobilize 1 trillion euros of “sustainable investments” over the next decade. “The EU Green Deal went even greener over the past year, with increased climate targets, disclosure requirements, and adoption of green budgets,” added Hecker and Dubourg.

Moving into the Mainstream on Outperformance

ESG in numbers:

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ESG fund universe grew by more than 100% during 2020 with total ESG assets now estimated at $7.2trn versus $3trn in 2019

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U.S. experienced the biggest adoption increase in 2020, but more than 80% of sustainable assets still reside in Europe

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JESG indices outperformed baseline indices by ~40bps in 2020 and assets tracked against the JESG indices now exceed $20bn


The pace of ESG adoption in the asset management community more than doubled during 2020, with growth of the ESG fund universe exceeding 100% over the past year and total ESG assets now estimated at $7.2 trillion versus last year’s $3 trillion estimate, according to Senior Global Markets Strategist, Nikolaos Panigirtzoglou. U.S.-domiciled sustainable investments increased to $17.1 trillion at the beginning of 2020, up 42% from $12 trillion two years earlier, according to a survey from US SIF: The Forum for Sustainable and Responsible Investment. Nearly $1.5 trillion has flowed into ESG funds since December 2019, taking the total assets under management beyond $3 trillion, according to data insights company Refinitiv Lipper.

The U.S. has seen the biggest adoption increase, but more than 80% of sustainable assets still reside in Europe, with the potential for U.S. cash flows to rise substantially. In our U.S. Fixed Income Strategy client survey for 2021, ESG came out as the top asset class for increased allocations. Some investors now view ESG as a “safe haven” in times of crises, with 48% planning to add exposure, exceeding high yield (37%) and EM (37%) by a wide margin, and only 1% planning to reduce exposure.

ESG ranked as the top asset class for increased allocations in 2021 60 % 48 % 37 % 37 % 36 % 31 % 26 % 25 % 23 % 19 % 18 % 15 % 15 % 14 % 13 % 12 % 12 % 11 % 11 % 50 % 40 % 30 % 20 % 10 % 0 % Source: J.P. Morgan ESG High Yield EM IG Corporates Equities TIPS Taxable munis Commodities ABS CLO Agency MBS Non-agency MBS Duration risk SSAs Cash/Money markets CMBS Treasuries Agency debt

Major Asian economics - China, Japan and South Korea - announced net zero/carbon neutral targets in 2020 with China outlining its goal to reach peak CO2 emissions before 2030 and achieve carbon neutrality by 2060, notes Elaine Wu, Head of Asia ex-Japan ESG and Utilities Research, who launched the Asia ex-Japan ESG Model Portfolio with top ideas across various sectors in the region.

During 2020 there was growing evidence of positive correlations between ESG and financial performance. J.P. Morgan’s ESG indices and ESGQ stock selection framework outperformed during the COVID-19 induced crash, strengthening the rationale for investing in ESG strategies. Morningstar notes that virtually all ESG index funds outperformed their conventional benchmarks in 2020 because they were underweight energy, one of the worst-performing sectors. Gloria Kim, Head of Global Index Research, highlights that J.P. Morgan’s JESG indices outperformed baseline indices by ~40 basis points in 2020, and assets benchmarked against the index suite outpaced expectations to exceed $20 billion, with the potential to double in the next 12-18 months. Similarly, over the five years through end-2019, Morningstar finds that 64% of U.S. sustainable funds placed in the top half of their categories.

Group 3 Created with Sketch. Assets benchmarked to J.P. Morgan’s ESG Index Suite, JESG, exceed $20bn and could double in the next 12-18 months JESG benchmarked AUM; $bn 20 18 13 12 3 3 Dec 2018 Dec 2019 Jan 2020 Oct 2020 Dec 2020 0 10 15 20 Source: J.P. Morgan

The green bond market also passed a major milestone in 2020, surpassing $1 trillion, while the corporate global green, social, and sustainability market grew to a record $600 billion. Global green, social and sustainability (GSS) bond issuance reached a record $392 billion in 2020, up by more than 40% from 2019 issuance. Equities have received the bulk of ESG flows in 2020 through passive investment via exchange traded funds (ETFs), but there is considerable scope for growth as ESG Equity ETFs represent less than 1% of total equity ETF assets but accounted for more than 30% of all equity ETF flows for the first four months of 2020.

J.P. Morgan’s Approach to ESG Investing

In April 2018, J.P. Morgan created the ESG Index Suite (JESG) by introducing the JESG suite of emerging market bond indices. The ESG Global High Yield Corporate Index (JESG GHYCI) and Asia Credit ESG Index (JESG JACI) were later launched in 2019.

Through the JESG indices, J.P. Morgan provides scoring coverage for over 6,000 global corporate and quasisovereign issuers across 14 sectors and 173 sovereigns. In November 2020, J.P. Morgan expanded its ESG index suite and launched the Green Bond Index (GENIE) that tracks 430 green instruments by 216 issuers across 40 countries with an aggregate market value of $441 billion.

Since 2018, J.P. Morgan has used an ESGQ proprietary stock selection metric with eight dimensions that helps investors pick stocks in a responsible way by prioritizing ESG factors. ESGQ now covers a universe of 5,547 stocks globally and is constructed using three building blocks:

Created with Sketch. Stability in ESG scores by using slow- moving and infrequent data variables that capture the long-term corporate responsibility profile of a company and couples these scores with: 1
Created with Sketch. 2 Faster moving ESG data that isolate news flow on potential controversies
Created with Sketch. 3 Momentum from these scores captures changes in investor sentiment and price behavior
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Stability in ESG scores by using slow-moving and infrequent data variables that capture the long-term corporate responsibility profile of a company and couples these scores with:

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Faster moving ESG data that isolate news flow on potential controversies

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Momentum from these scores captures changes in investor sentiment and price behavior

“ESGQ is a better way to invest,” notes Global Quantitative Strategy Analyst Khuram Chaudhry, “as ESG metrics can help investors pick stocks in a responsible way that outperforms the index and also increases the ability to spot the next controversy.”

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