Q4 2021 Equity Manager Report: ESG Funds Swell To 10% Of Global Fund Assets At Year-End Seeking AlphaQ4 2021 Equity Manager Report: ESG Funds Swell To 10% Of Global Fund Assets At Year-End Seeking AlphaQ4 2021 Equity Manager Report: ESG Funds Swell To 10% Of Global Fund Assets At Year-End Seeking Alpha
Impact Investing Forum 2023
London. May 04-05, 2023.
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Russell Investments2.11K FollowersSummaryInformation technology, utilities, and materials were the clear winners across most regions.
Expectations that the Fed would tighten sooner than expected resulted in a decrease in risk appetite
Managers expect modest absolute returns for small-cap stocks by 2022, with the Fed likely being less accommodating.
Khanchit Khirisutchalual/iStock via Getty Images
Did 2021 mark the year that environment, social and governance (ESG), issues were at the forefront of investors’ minds? The numbers prove it. ESG-focused funds received $649 billion in the last year. Investors began to push for conversations on climate change and social justice with regulators and companies alike. The massive capital influx led to ESG funds accounting for roughly 10% of global fund assets by 2021. The year saw several notable ESG movements, as a rise in shareholder engagement and a call-to-action from governments worldwide to address the climate crisis. 2021 ended on volatile notes, with the emergence and continued uncertainty over inflation, rate hikes and China’s slowdown dominating the headlines. These fears obscured what turned out to have been a strong quarter for equity regions other than emerging markets. The best performing factors in the quarter were low volatility and quality. However, the growth factor performed poorly in most regions while the value factor had mixed results. Importantly, the style was less of a driver of performance throughout the quarter, with stock selection being of greater importance.Information technology, utilities, and materials were the clear winners across most regions. Managers are becoming more critical about the extent of recovery and remain optimistic about the economy. Given the volatility of inflation, managers are choosing to have stronger balance-sheet businesses that can charge more. Managers also point out that year-over-2018 earnings improvement may be more difficult in 2022 than 2021 due to the base effects. We have compiled these insights and others from specialists across the manager universe into an easily-read report. Below are the key tactical observations from key equity regions and geographic regions worldwide during the fourth quarter 2021. We have also added a section on ESG investing at top. This shares the key trends that our manager research team sees in the next year. Scope 3 emissions disclosure Scope 3 emissions account for 65-90% of all emissions for many companies.
Radical transparency to assess the company’s impact on the world and not the world’s impact on the bottom line.
Green deals require private capital. Industry figures show that large private equity firms have the potential to increase their exposure to renewable energy.
This indicates growth potential for environmental portfolios.
Private capital is interested in climate tech investments.
Larry Fink advocates for private company disclosure of environmental information.
Green bondsThe green bond market is expected to continue to grow. Investors will be more careful about what qualifies for green.
Carbon marketsPost-COP26 governments will look to use existing (European Union), and new (China), carbon markets to reduce greenhouse gas emissions.
Although carbon credit prices have been on the rise, they are still not high enough to stop significant emissions.
Sustainability accountabilityGlobal standards are consolidating, using the Task Force on Climate related Financial Disclosures (TCFD), in the UK and EU, as a guide, as well the International Financial Reporting Standardss (IFRS) in the EU. The Securities and Exchange Commission (SEC), in the United States, is expected to make a statement in 2022.
The S in ESG is the most important
Australian equitiesChanges in capex mix support inflation being transitoryCapital expenditures (capex), now account for 52% of total capex. Because the inputs are more easily sourced and not finite, soft capex causes less demand-pull inflation. The pandemic’s restricted movement has temporarily increased consumer demand, which temporarily spiked demand-pull inflation. Some expect this to reverse in mid-2022 as movement returns to pre-pandemic levels, supporting their overweight to the information-technology (IT) sector.
Greenwashing offsetAnalysis has shown that the efficacy and effectiveness of the two largest offset sources is questionable. Due to the lower cost of renewable energy and avoided deforestation (33% of carbon offsets), it is likely that these projects will go ahead without offset funding. The trees may have stayed anyway. Managers are looking at this as a way to offset their own emissions and as a way to benefit from offsets.
Canadian equityInvestment opportunities down market cap spectrum
Trending downwards in active size exposure of the median manager has indicated increased interest in smaller capitalization businesses.
Attractive valuations, opportunities for productive ESG-oriented engagements and better liquidity are all factors that support increased interest.
Banks will benefit from favorable environment in 2022. Increased lending activity, recovering consumer fee revenue, an increase in capital markets activity (mergers & acquisitions), large cash positions, healthy dividend yields and attractive price multiples all represent tailwinds to banks.
Expected year over-year dividend growth
COVID-19 + Inflation + Interest Rates = Volatility. The uncertainty surrounding the impact of COVID-19, nonconsensus views about inflation and mixed central bank tapering plans are creating confusion and irrational investor behaviour, as well as periods of extreme volatility.
Managers expect volatility to continue into the first half 2022. This creates opportunities for active management, especially in heterogeneous markets like the industrials sector.
Emerging markets equitiesClouds lifting in support of a China recoveryPolicy stabilisers and reacceleration actions have provided reassuring liquidity assistance, attracting some Chinese investors back to China – contrary to the global tapering picture.
The anti-carbon regulations that had stalled last year’s factory production were relaxed. This opens the door to an industrials revival.
The ability to access credit is helping property-developer balances. As the market stabilizes, assets become more attractive.
Investors are slowly returning to the devalued Chinese internet, with attractive forward-growth and regulatory risks now priced into.
Stimulus policies continue protecting Chinese renewable energy, battery chemicals, and the electric vehicle (EV), space from pandemic uncertainty.
Avoiding political headlightsRussian sanctions risk is being reduced by investors due to Ukraine’s border escalations with a U.S-led NATO (North Atlantic Treaty Organization).
Managers approach Brazil with caution due to the political volatility during the election cycle. There are many attractive opportunities and the currency is still attractive.
SeaBulk’s bottom-fishing operation and container shippers have been able to reap the benefits of a tight supply chain and continued demand. The industry dynamics are expected to continue through 2022.
Energy is a neglected area that offers rich dividends. This is offset by healthy spot prices, and a potent upside.
Actively covering for inflation expectationsInvestors are taking profits in both high-growth and deep value segments of the market, due to the volatility caused by anticipated U.S. rate hikes and negative sentiment.
Wage inflation has increased in COVID-disrupted retail and hospitality sectors. Managers are choosing resilient names that will benefit from a deflationary opening effect and the normalization in emerging markets’ long-term secular consumer story.
Europe and UK equities Value opportunities are diversifyingThe value set is expanding beyond the depressed travel and auto name markets. Managers are looking at not only cyclical names and banks, but also areas like defensive stocks.
Europe: Earnings per share (EPS) expectations for 2022 and 23 remain low. The broad market consensus is that the current recovery in company earnings will be short-lived. The EPS forecasts for 2022-2023 are lower than historical averages and not in line the general GDP (gross Domestic Product) growth consensus.
Europe: Inflation is here and will continue to rise. Companies are slowly absorbing the sharp increase in input costs. We expect price increases to continue through 2022. This, along with ongoing supply chain woes, will keep inflation at higher levels and help cyclicals.
UK: The UK’s cyclical valueValuations are still attractive. Managers are increasing the value of cyclical names that can perform well in an environment with higher inflation and higher interest rates.
UK: Environmental thematicMany managers are increasing their exposure to environmental thematic plays. These companies faced a challenging 2021 due to rising bond yields, supply-chain disruptions and spiked inflation. These managers believe that these headwinds will pass and they are buying back into them at attractive valuation entry points.
Global equities Managers are more cautious as pandemic conditions and expectations continue to shift rapidly, driving volatility in markets. Investors are becoming more cautious about inflation and earnings will be difficult to compare year-over-year. Profit margins are already very high, and in some cases unsustainable.
Inflation causes the Federal Reserve to apply its brakes. A hawkish U.S. Federal Reserve could slow down economic growth. Last year, companies were able to pass costs on and increase margins. However, slowing year-over year growth and rising costs will likely reverse this trend. Managers are looking for idiosyncratic growth and de-risking at the margin.
The style trends are muted. Security selection carries the quarterQ4 2020 factor performance trends. These trends reflect a year with no clear winners. Investors were cautious last quarter and favored quality and low volatility, indicating a cautious outlook. Managers that outperformed their benchmarks were more focused on security selection than allocation.
Managers acknowledge that the markets remain narrow despite the correction in highly-valued stocks. While value investors continue to point out the positive effects of economic expansion and valuation spreads on value investing, moderating economic growth could be a hindrance for value investors.
The complex relationship between climate and energy trends presents a challenge set. European regulators might label natural gas or nuclear energy green, in a pragmatic, but controversial, approach to the energy transition. This could have long-term capital implications.
There are conflicting socioeconomic, geopolitical and climate goals. Investors and governments must deal with high energy prices, which can hurt consumers, and the environmental effects of mining for low-carbon energy products and systems.
Japan equitiesFocus upon Fed’s tightening policies. Expectations that the Fed would tighten sooner than expected – due to high inflationary pressures- led to a decrease in risk appetite. The most severe impact was on small-cap growth stocks.
Many managers feel it’s too early to invest in small-cap growth stocks. Despite attractive valuations, rates are expected to rise faster than anticipated. The main concern of value managers is the possibility that policy tightening might harm economic growth.
Mixed views on the sustainability and inflationary pressures
Many market-oriented growth managers have attempted to diversify their portfolios in the face of uncertainty. Value managers increased defensive value stocks while reducing cyclical values stocks that performed well.
Reopening theme delayed but still in motion
Managers with less exposure to this theme are now more open to the possibility of adding exposure to beneficiaries (e.g. retail) that have attractive valuations.
Inflation and currency headwinds Some expect Japan’s core CPI will rise more than consensus because of the yen’s decline. They are therefore retaining positions in financials that will be able to benefit from future rate increases.
Long/short equityA significant deleveraging event leads to a wait-and see approachEquity long/short managers entered 2021 risk on, maintaining high gross exposure and net exposure levels for most of the year.
Significant deleveraging and factor rotations were triggered by changes in the Fed’s outlook regarding inflation, along with new concerns about the omicron variant.
Managers are now defensively positioned, reducing overall gross exposure while focusing on capital preservation and conviction.
Long alpha continues to lag, especially in crowded names. Short alpha quickly recovered after the first quarter 2021 and ended up positive for the year. Long alpha lags partly due to (market) factor rotation, from growth to value. The spread between growth and value net exposure reached a five-plus year low.
December was the second-worst month since 2009 for long alpha. Crowded longs performed poorly in all regions, particularly in North America and Asia.
Custom short baskets Managers are using custom short baskets more often to hedge against certain sectors or factors.
Reduction from unprofitable/expensive techAfter maintaining a high exposure to tech throughout the year, managers have aggressively reduced exposure to unprofitable/expensive tech (currently at ~1.5-year lows). ?
Real assets equitiesIncreased M&A activity in real estate in 2021Last Year saw 15 U.S. transactions totaling $6.6 billion. There was a 21% premium announced, which was split between privatizations or public-to-public trades.
Managers see more opportunities, especially in the apartment sector.
Real estate trendsOffice. Uncertainty about space requirements is reducing leasing and transaction activity. Businesses moving to Singapore are a boon for the country.
Retail: Strong leasing volumes in open-air centers through 2023. The malls are able to recover from a low valuation base.
Residential: The U.S. coast markets are under threat from population outmigration to the Sun Belt, suburbs, as well as rent control initiatives.
Industrial: Continuation e-commerce-driven space demand
The property level fundamentals are improving. Long-term earnings growth is above the average with increasing estimates.
A stronger economy could drive rates higher and cause inflation, but it may also drive demand to many types of real estate properties, which may allow landlords to raise rents.
Infrastructure lagging economic recovery offers opportunitiesInfrastructure is cheap relative to global equities, based on enterprise value/EBITDA (earnings before interest, taxes, depreciation, and amortization) multiples. The current spread is 0.2x, compared to the long-term average 1.1x.
The pace of renewable energy deployment is increasing, which supports U.S utilities. The investment thesis has been updated to include electric grid updates.
Communications infrastructure is benefiting from data growth.
In 2022, airport recovery is expected to accelerate.
Midstream energy companies can generate higher free cash flow due to a supply/demand imbalance, and by using a more profitable business model.
U.S. large cap equitiesOptimism in reopening-related sectorsThere is a positive outlook for consumer stocks and other industries that have experienced slowdowns due to pandemics. Reopening-related stocks are attractive because of the fact that consumer spending ebbed and flowed due to the omicron COVID-19 variations and are able to earn substantial earnings upside.
Investors expect increased demand to drive higher spending in travel-related industries as well as autos. Activities will also benefit medical device companies.
Inflation and the ability to pass priceWith expected inflationary pressures to continue, managers continue to highlight companies with pricing power and the ability to maintain profit margins.
The environment is favorable for energy-related stocks. They have become more focused upon cash flow and profitability after the 2015 crash in oil prices.
Banks have a favorable outlook.Bankers continue to be bullish because of the prospect for rising interest rates, which will support a higher net-interest margin for lenders. Large-cap banks have seen a significant reduction in their cost structures since the outbreak of the pandemic. They have also increased their technology usage.
Software and internet stocks face difficult comparisonsStrong growth in e-commerce and software-as-a-service companies is expected to persist. These businesses will likely have difficulty exceeding investors’ earnings expectations due to the pandemic-fueled boom.
Managers are more selective about software and internet companies and are now focusing on emerging mid-cap names at an earlier stage of their growth cycles.
U.S. small-cap equityMuted outlook on small caps, positive outlook to active managementManagers expect modest absolute returns for small-cap stocks by 2022, with the Fed likely being less accommodating. Importantly, small caps have not delivered double-digit returns for four years in succession.
Managers of small-cap companies believe that active management has been able to thrive in low-return environments.
All styles have the same position in energy and banking. Managers of all types (including small-cap growth), expect that the favorable environment for banks and energy will continue into 2022.
Small caps and inflation
Value managers are more sensitive to cyclicals. Valuation managers believe that valuations in early cyclical stocks (such as industrials) are relatively high and that companies are close reaching peak earnings.
Value managers are moving into areas that offer easier year-on-year comparisons, such as travel and leisure, autos and event management.
Although growth managers recognize stretched valuations in technology, they aren’t abandoning the sector. Technology valuations remain above historical averages after reaching their peak in November.
The strong fundamental growth of tech companies continues to be highlighted by growth managers. They believe that continued consolidation from strategic or private equity acquirors can provide support.
Bottom line: While managers are optimistic about the economic growth prospects in 2022, rising rates and persistent inflation mean that superior, risk-adjusted returns may be more difficult than in previous years. We believe that specialist managers’ views will be crucial in identifying new opportunities and exploiting market inefficiencies in such a context. As the new year begins, we look forward to sharing these insights with you. Source: Refinitiv Lipper Data from Morgan Stanley Prime BrokerageDisclosuresThese views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. Data from Morgan Stanley Prime BrokerageDisclosuresThese views are subject to change based on market or other conditions and are current as of the date at the top of this page. This material does not represent a projection of the stock exchange or any specific investment. You should not act on the general information in this publication without seeking specific legal, tax, and investment advice from licensed professionals. They are not likely to grow at an equal rate of return and could experience negative growth. They do not grow at an even rate of return and may experience negative growth. The Russell Investments group of companies is not affiliated with Frank Russell Company. It is provided “as-is” without warranty. Russell Investments is proud to continue its 85-year legacy of innovation and providing exceptional value to clients. Every day, Russell Investments strives to improve people’s financial security. Russell Investments is headquartered in Seattle, Washington. There are 19 offices around the globe, including New York, London and Tokyo. Russell Investments is owned by a majority stake by funds managed TA Associates and a minority stake by Reverence Capital Partners and Hamilton Lane Incorporated. All trademark rights related to Russell trademarks are owned by Frank Russell Company. FollowComment
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