Socially responsible investment funds have boomed in popularity, particularly during the COVID-19 pandemic, when they seem a safer haven amid uncertain financial markets.

However, their growth has attracted increased scrutiny from the Financial Services Agency, which is keeping a closer watch on environmental, social and governance (ESG) investment products.

The total net asset balance skyrocketed fivefold to 2.3 trillion yen ($20.91 billion) over the previous year for investment funds touted as carefully choosing which businesses to invest in from an ESG standpoint.

But the investee selection criteria for many funds are unclear. In addition, it is apparent that their investment performance doesn't exceed other financial instruments.

Still, their popularity surprised even firms offering the ESG funds.

“Investors expressed far higher expectations than we had expected during the novel coronavirus crisis,” said Yukinobu Hida, head of the product development department of Mizuho Securities Co.

Hida referred to the Future World ESG investment trust, which was marketed in July last year by Mizuho-affiliated Asset Management One Co. to pump capital into 25 businesses in eight nations, including Amazon.com Inc. in the United States.

The fund’s sales were so brisk that 150,000 people have bought it within less than a year, and its asset balance has reached 1.1 trillion yen. The fund’s value has risen 1.2 times more than the initial figure since its release.

As the trust fund invests in companies expected to enjoy continuous growth, Hida said he would like customers to “keep holding the fund for 10 years or longer.”

In December last year, the FSA cast doubt on the sought-after product, noting that “more detailed explanations should be offered about such elements as the standards for selecting the businesses to invest in.”

The reasoning was that 90 percent of the new fund’s investee corporations are the same as those of the existing Future World fund, making it unclear how those firms are committed to ESG efforts.

The rare criticism from the FSA questioned the validity of the investment fund, which appeared to cater to “ESG only nominally.”

Mizuho spent a month reviewing the prospectus and monthly report to provide a more detailed explanation about the product, with ESG activities of the top 10 businesses newly explained.

To clarify the links with ESG, it was stressed that the firms “mainly involved in alcoholic beverages, tobacco, gambling, fossil fuel production and weapon manufacturing” are not included in the fund as well.

JUMPING ON THE BANDWAGON

According to the Japan Sustainable Investment Forum (JSIF), 143 ESG-related investment packages are available as of March, 28 more than that for the same month a year earlier. Their asset balance increased five-fold to 2.355 trillion yen.

“Seeing the success of Mizuho, other companies have successively introduced similar products,” said a senior FSA official. “In many cases, no explanations are given about why they are connected to ESG.”

The FSA analysis results released on June 25 showed ESG-touted investment funds’ average ESG score--an indicator for ESG friendliness--falls slightly short of even a trust fund linked to the Nikkei 225 index.

With that in mind, the FSA is planning to call on asset management firms to provide clear explanations when handling investment funds billed as ESG friendly, using the greenhouse gas emission reduction information and other factors.

Monitoring of securities companies and other retailing businesses will be tightened likewise.

In the EU, the Sustainable Finance Disclosure Regulation (SFDR) took effect in March with the aim of allowing investors to more easily compare ESG investment funds.

Investment funds will be rated on a three-grade ESG-compatible scale under the new regulation. It will be made mandatory in phases to show the rating at the time of contracts and on other regular occasions.

LOWER PROFITABILITY

Another problem for “nominal ESG funds” is their lower profitability. For example, a sales commission of up to 3.3 percent and the annual fund fee of as high as 1.84 percent are charged for Future World ESG.

ESG-based products’ fund fee, or their core cost, is as much as triple that of index funds designed to track the performance of financial market indexes, whereas the investment outcomes of the two types of financial commodities are almost the same.

ESG funds’ Sharpe ratio, which refers to the efficiency of investments, is not exceptional as well.

Market players are skeptical about the product concept of ESG-friendly funds, and the senior FSA official pointed out the ESG trend “may quickly end as a temporary boom like in the eco-friendly investment fund fever of 20 years ago.”

“The commissions are expensive and diversified investment effects can hardly be expected, so such products’ investment efficiency is often bad,” said economist Hajime Yamazaki. “Another disadvantage is that companies that might make dramatic ESG improvements in the future are excluded.”

Yamazaki recommended that individual investors should “separate investments from social activities,” if they hope to amass enough of a return to keep pace with life expenses after they retire.

“Those people should choose funds linked to the world’s stock index and other market indexes, and make donations and engage in environmental campaigns while benefitting from those funds,” he said.