Environmental, Social and Corporate Governance (ESG) focused investments have grown by more than 750% since they were first mentioned in the 2006 United Nation’s Principles for Responsible Investment (PRI) report. With the considerable growth in ESG investing, ESG factors are being incorporated within the financial evaluation of companies. At the time of writing, there are 4996 signatories, composed of asset owners, asset managers and service providers who represent over $121 trillion in assets under management per the latest PRI report.
The consideration of ESG factors is of increasing importance for investors and has become a critical component of investment decision-making in recent years. The shift in attitude is caused by a wide range of factors, including the increasing awareness of climate change, the benefits of strong corporate responsibility on company performance, and the knowledge the next generation of investors have on the pertinence of ESG factors when making investment decisions. Investment managers have been required to change the traditional nature of investment decision making to incorporate ESG factors.
Millennials and Generation Z are also more likely than previous generations to make purchasing or investment decisions based on personal and ESG values. A 2018 Spectrem Group study indicated that more than half (52%) of millennial investors see ESG issues as important investment criteria, compared with less than 30% of baby boomers and 42% of Gen X investors. To serve the growing pool of ESG investors and the increasing demand for ESG data, the major index providers have created ESG indices to evaluate and rank ESG factors across various companies. The four major rating agencies for ESG data in the current market include MSCI, FTSE Russel, Bloomberg, S&P Global and Moody’s. Trailblazers in the ESG rating space include specialist firms such as Sustainalytics, RepRisk, and ISS.
According to Pension and Investments, sustainable investments currently account for more than 10% of the $400 trillion in global financial assets. Projections state that this is likely to increase to more than a third of global financial assets by 2025, with sustainable investments looking to reach $140 trillion. The capital inflow to ESG-focused funds more than doubled between 2019 and 2021 (Fig 1a). According to Refinitiv’s Lipper Fund Data record $649 billion poured into ESG-focused funds worldwide last year, up from the $542 billion and $285 billion that flowed into these funds in 2020 and 2019, respectively, according to Morningstar. Comparing ESG index funds to their traditional equivalents, the average of 13 US Large Cap ESG index funds outperformed the iShares Core S&P 500 ETF between 2019 and 2021 (according to Morningstar). Figure 1b).
We can see from S&P Global Market Intelligence that during Q4 of 2021, institutional investors bought 68 million shares in 10 renewable energy companies. This displays a definitive shift in investors’ decision making and the inclusion of ESG stocks into their portfolios.
As a global ESG investor, the importance of optimizing foreign withholding tax (WHT) recoveries cannot be understated. Reducing tax drag has an appreciable effect on investment performance, even more so if the reclaimed funds are reinvested over an extended period. To demonstrate this, we looked at a selection of the top five holdings (ex. China) of an EU domiciled emerging market sustainable fund. The total dividends of these holdings amount to $26.9 million and the total WHT withheld on income amounts to $5.6 million. Depending on the investment structure and the local tax laws, the fund should be able to recover $2.5 million at a minimum. There are additional reclaim methods used that can reduce the WHT rate to as low as 0% in certain instances. Using WTax, at least $2.5 million could have been reinvested into highly rated ESG stocks, thereby improving short term and long-term performance.
To highlight an additional reclaim method, we looked at an American domiciled investor who holds more than 125 thousand shares in LVMH Moet Hennessy Louis Vuitton SE (LVMH), a French-based multinational corporation and conglomerate specializing in luxury goods. At the time of writing, LVMH posted a low comprehensive ESG Risk Rating of 12.4 according to Sustainalytics. In addition to this, with a valuation of $329 billion, LVMH became the most valuable company in Europe in 2021.
In Q1 of 2022 LVMH declared a dividend of $7.66 per share, which equated to $969 thousand for the American domiciled investor. The French tax offices levies 25% of the dividend being paid to foreign investors, equating to $242 thousand. WTax recovers the difference between the gross rate (25%) and treaty rate (15%) on behalf of the investor i.e., $96.9 thousand (10%). Furthermore, WTax can submit a European Court of Justice (ECJ) claim that could reduce the withholding tax down to 0%, thereby allowing the investor to reinvest or return to investors the full $969 thousand.
WTax can recover unclaimed WHT on behalf of investors through a bespoke end-to-end recovery solution. WTax has set a new industry standard for WHT reclaim solutions and reporting which provides access, accuracy, and transparency to all investors.