The future is ESG investing

Popularity of sustainable investing grows as 10s of billions pour into funds.

Many of us want to make a positive contribution to the world that we live in and one way in which you can help is choosing how your money is invested. This includes choosing to invest your money in funds where the managers have chosen to invest in companies that work towards improving the Environment, addressing Social inequality or Governance improvements (ESG investing). 

The rise of ESG investing

Whilst most of us  may be aware of the various challenges impacting societies across the globe, we have recently begun to see a dramatic increase in investors voting with their feet and taking action to make a positive change with their money.

The chart below illustrates just how dramatic this increase has been, with 10s of billions of euros now being directed into sustainably managed investment funds each quarter, in Europe alone.

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https://www.morningstar.co.uk/uk/news/204525/sustainable-fund-flows-hit…

What is even more interesting to note is that throughout the initial investment market shocks caused by reaction to the Coronavirus pandemic, European sustainable funds continued to record strong inflows in excess of €20billion. This is a stark contrast to outflows experienced in traditional equity markets.

What is causing the change?

In the short term, we believe there are two key factors behind the movements.

Knowledge & Awareness

Firstly, individuals are becoming increasingly aware of environmental, social and governance challenges around the world and the important part that large companies can play in improving, or exacerbating, these issues. 

You only have to switch on the news to see frequent stories relating to climate change, racial inequality and company-specific reports of accounting scandals and poor working conditions. This increased education and awareness is leading to many wanting to take real action.

As well as trying to make a positive impact with their money, investors also have reason to believe that adopting an ESG approach does not necessarily mean acceptance of lower performance. This is because, in theory at least, companies that demonstrate their awareness to ESG principles are more likely to have higher standards of corporate governance, which should translate to improved resilience in adverse economic conditions.

Accessibility

The second influencing factor is largely a result of the first, because as demand for more sustainable investment approaches has increased, so too has the amount of investment providers attempting to “follow the money” by making ESG products available to investors.

This doesn’t just apply to professional investment managers and financial advisers, as there is a growing range of ESG funds available to DIY investors, as well as online and app-based ESG portfolio services.

Will the rise of ESG investing continue?

In short, yes.

Alongside growing demand from investors, sustainability issues are being prioritised at the highest level.

In 2015, the United Nations introduced their 17 Sustainable Development Goals (SDGs) which they describe as a "blueprint to achieve a better and more sustainable future for all". The governments of all 193 member states are expected to use the SDG framework to develop their political policies, with the aim of achieving the goals by 2030.

With sustainability issues shooting up the priority list of governments around the world, this has begun to translate into improved regulation in this area. As an example, the European Union (EU) has developed a common classification system to identify whether certain economic activities are deemed “environmentally sustainable”, which will in turn allow the sustainability of any given investment to be determined.

The main aim of this regulation is to facilitate investment into environmentally sustainable economic activities.

Therefore, it is only reasonable to believe that this type of regulation will lead to increased future investment into companies that fit the ESG criteria.

In addition, companies will continue to be subjected to an increasing set of non-financial reporting requirements which include disclosing their ESG impact. When coupled with increasing investor demands, this is likely to affect less sustainable companies’ ability to raise capital for expansion. 

How might the changes affect your investments?

The largest asset manager in the world, BlackRock, this year called for CEOs to disclose more clearly how they are managing sustainability and warned that companies who do not respond to sustainability risk will be on the losing side of a significant reallocation of capital. 

What is even more important for investors, however, is their statement confirming “we believe that sustainability should be our new standard for investing”. 

Not only are they calling for others to make change, they have committed to accelerating the integration of sustainability throughout their investment process. Amongst a variety of commitments, they have pledged to expand their ESG fund range, make sustainable strategies their standard offering and to exit holdings in thermal coal producers.

Larry Fink, BlackRock CEO is quoted as saying “Over time, companies and countries that do not respond to stakeholders and address sustainability risks will encounter growing scepticism from the markets, and in turn, a higher cost of capital.” *

If the change in direction of the largest asset manager in the world is anything to go by, we believe that we are only likely to see more and more managers following this route, or they risk being left behind.

What this could mean for investors in the not too distant future is that, it is not absurd to assume that all collective investment funds will be compelled to consider the ESG criteria of any company they invest in, alongside financial considerations.

This could lead to all investment funds eventually being considered as taking an ESG approach, although the level of sustainability would vary widely between each fund.

Active ESG vs Passive ESG 

Whilst we have seen actively managed investment funds in the ESG space for some time, it is particularly interesting to see the rise of passive investment funds in this category.

In recent years, passive investments have become increasingly popular amongst investors. In fact, Bloomberg estimated that in 2019, actively managed US equity funds experienced total outflows of over $200 billion, whereas passive US equity funds benefitted from inflows of over $150 billion. **

Active Investing Where a fund manager selects investments they deem to be attractive, in an attempt to outperform a benchmark.
Passive Investing Owning a portion of every investment within a given index, to match the performance of the index. 

There are already a number of financial indices available to investors seeking to invest passively in an ESG approach. One of the most well-known is the FTSE4Good index series, established in 2001, which follows the performance of companies demonstrating strong ESG practices.

However, as demand increases, so too does the number of passive investment options available to investors. 

The most notable of these came this year from Vanguard, the world’s second largest asset manager. They launched two passive ESG funds in June 2020, providing global exposure to investment markets with an ESG tilt. 

What now?

With increasing action from governments, companies and investors alike, it is hard to see how ESG considerations will not be incorporated into all of our investment decisions at some point in the future.

However, it is clear that there are a number of challenges to overcome before that point is reached.

Although growing, ESG investments represent only a relatively small pool of the investment universe. 

In addition, Europe is the sustainable capital of the world at present and is therefore leading the way on sustainability. Less developed markets are still behind in this area and, although there are good news stories, it is likely to take them much longer to adopt similar principles at scale.

The world still also lacks common sustainability criteria and terminology that can be applied globally. This means that measuring the sustainability of any given company or investment is likely to be opaque.  

Given the challenges, we certainly still believe that there is a place for more traditional investment strategies within our clients’ portfolios. 

If you would like to discuss how you could align your money with your personal values, click here to speak to one of our independent financial advisers

Learn more about ESG investing at our next free webinar where our experts will take you through the key principles of ESG Investing and how it might benefit your financial future. Click here for more information.

Past performance is no guarantee of future returns. The value of investments and the income from them can fall as well as rise, you may not get back what you originally invested.   

Source:
* https://www.blackrock.com/corporate/investor-relations/larry-fink-ceo-letter
** https://www.morningstar.com/articles/961935/2019-fund-flows-in-9-charts