I was invited to evaluate the investment portfolio of an ESG fund to identify the fund's problem, as its asset value has suffered reductions since its creation.
To begin this investigation, I asked what the intention was in offering clients an ESG fund.
The answer was something like this: " We offer ESG funds in response to the growing demand for socially responsible investments , aligning ourselves with our clients' ethical and environmental concerns. "
In my style, lose the client but not the opportunity. I told them: if that was the intention, mission accomplished. Is there anything else I can do for you?
A word about ESG:
Jokes aside, there is actually no long-term development without respect for the environment, people, the community and our values as a society . If we destroy our home, planet Earth, we will soon be left with nothing to sustain us and nowhere to go on the cold nights to come. Therefore, what we call ESG is not a requirement, but a basic need.
Why did the ESG fund suffer losses?
Firstly, the interest rates of fixed income in recent years, which reached 13% per year, cause investors , the vast majority of whom are traditional, to allocate their resources to government bonds and real estate . This would explain 50% of our question.
Secondly, we have inflationary pressures eroding companies' purchasing power. In this scenario, high interest rates remove liquidity from the market , affecting the dynamics of sales, profits, dividends and, as a final consequence, the price of a share.
Third, whenever we use the ESG filter in our research, we need to know that we will pay a premium for the share , as many funds can only invest in companies listed within the ISE B3 index or similar. Therefore, competition for these assets , considered premium, is greater.
Once the villains are identified, give us solutions!
The first is to read the fund's statute and see what can be done without violating the established premises and policies .
Image of the Fund's Investment Policy.
Once this is done, I discovered that 95% of the capital must be allocated to other investment funds . This leaves us with no internal maneuver to overcome the situation, but not without alternatives.
The hardest part comes now: understanding what to expect from the financial market in the future. I have very strong statistical views, perceptions and projections of what to expect going forward. Anyone who follows me in my lives knows that I'm expecting a flattening of the American market, which has an 83% correlation with the Brazilian market . Even though some assets here in Brazil are attractive, external winds can affect them strongly .
Therefore, the job now would be to conduct a comprehensive survey of the area of available ESG funds to see which of them may have extended cash positions and/or which of them are more allocated to less sensitive and even defensive assets.
Image: Morning Star BR.
As we can see, the fund is exposed to cyclical and more sensitive sectors , which raises concerns regarding high interest rates that remove liquidity from investors and consumers. Therefore, we can make adjustments here seeking greater security.
A word about insider risk: customers
On the other hand, it is crucial to consider that investors in ESG funds must have some investment knowledge . If the fund is made available to the general public, who generally monitor the investment balance constantly, it becomes challenging to manage a fund with long-term goals, given that its results are perceived over more than five years.
How can an investor improve the world?
We saw at COP28 the broad debate that society is facing about the burning of fossil fuels, and the intellectual and personal efforts that we will have to make to meet the needs of a growing society without permanently damaging what nature can offer us. In this context, I realize that my vision, values and purpose align. As an allocator of scarce resources in our society, I can work not only to generate gains, but also to minimize impacts, whether in the social or economic sphere.
What about the fair price of the fund's assets?
Cover Image by: Unsplash