It’s been hard to watch the news over this past year without feeling an urge to do something. Social inequality, stressed healthcare systems, and business practices that are harming people and our planet—these issues have all been very much on my mind, as well as in the global spotlight. Like many of you, it’s made me seek ways to take action.
One path is to evaluate where we put our money. Investors now have tremendous opportunities to promote social and environmental causes, including equity, diversity, community well-being, and protection of the planet. These opportunities are not just about improving our world, but they also seem to be wise investments: Four out of five studies1 suggest that sound sustainability practices can have positive influence on stock price performance.
Against this backdrop, here are some of the trends I’m seeing within the impact investing space.
1. Impact investing is surging and driving change
Research shows that sustainable investments can offer competitive performance2, and this possibility seems to be attracting considerable investor interest. Assets in sustainable investment funds have more than tripled3 over the past decade, in large part due to growing investor demand.
“Assets in sustainable investment funds have more than tripled over the past decade, in large part due to growing investor demand.”
Going into the COVID-19 crisis, there was already an appetite for socially responsible investments. The pandemic did not disrupt that trend. Morningstar reports that sustainable investing flows reached $20.5 billion in the fourth quarter of 20204, up from $7 billion in the fourth quarter of 2019.
Sustainable investments are proving resilient under certain market conditions that may favor ESG investing. They’ve done well5 in both up and down markets. Even during the COVID-induced downturn, sustainable funds generally outperformed4 conventional funds and indices.
These risk and return characteristics are appealing. In March 2021, sustainable assets totaled nearly $266 billion6 in the US. The number of new ESG indexes and products increased 30 percent between 2019 and 20204, and Bloomberg Intelligence projects that global ESG assets will exceed $53 trillion by 20257—more than one-third of the $140.5 trillion total assets projected to be under management. My guess is that the trend will only grow from there.
This isn’t just a conversation about how money will move tomorrow—the shift is happening now. Businesses and corporations are under scrutiny as consumers and investors watch in real time. To stay relevant, they’ll need to consider how they can change the way they do business to better reflect the social and environmental priorities of their clients.
It’s worth noting, however, that the skyrocketing popularity of ESG has led to what some analysts are calling a “green bubble,8” or the theory that the markets are facing over-investment in renewable energy in order to satiate investor demand. Some financial experts9 suggest that the levels of debt facing many clean tech companies are untenable in the long term. While the future is always uncertain, this may prove to be true for some companies and not for others that emerge as leaders in a new, low-carbon economy. As with any sector, ESG investments always require caution and due diligence.
2. Product innovation is gaining speed
A range of new products catering to exclusionary, ESG, and impact investors has exploded onto the scene, and this is likely to continue. A total of 77 sustainable funds launched in the US in 20204, breaking the previous high of 44 in 2017. There are now more than 1,000 ESG indexes10, as well as a multitude of different exchange-traded funds (ETFs) created to track those indices. Asset managers are poised to launch more than 200 new ESG funds in the United States between 2020 and 202311, which would more than double the activity of the previous three years.
In my opinion, more choice is a good thing for investors—as long as it’s coupled with clearer explanations of what products are designed to do, transparency of underlying investments, and avoidance of “greenwashing.” As seen, with a record high number12 of S&P 500 companies mentioning ESG during Q2 earnings calls, the popularity of ESG funds has led companies to seek out ways to ride the sustainability wave. This poses risks for investors looking for high quality corporations dedicated to environmental, social, and corporate governance matters. In some instances, the way that ESG ratings work currently, a business could score high enough on the social (S) and governance (G) metrics to be included in an index or portfolio, despite poor environmental (E) performance. I always encourage investors to exercise diligence or to work with an advisor to determine the proper investment vehicle(s) in order to match specific objectives.
3. Movement toward standardization and consolidation
As the world of sustainable investing evolves, investors and would-be investors are surrounded by a rising tide of information. Language is less than straightforward, and currently, there is no standardized definition of key concepts and principles. Even between the major ratings providers, there are differences in what is considered an E, S, or G factor, and the weighting of each. As a result, for example, the holdings of one of the popular iShares ESG Aware MSCI USA ETF13 includes fossil fuel stalwarts Chevron and Exxon Mobil.
While there are ongoing efforts toward standardization, consolidation may also have a part to play. For example, JP Morgan has acquired OpenInvest14, a move that might signal an industry shift away from multiple smaller firms to a few larger ones and ultimately, more uniformity. In addition, more than 2,000 investment managers15 have now signed on to the UN’s Principles of Responsible Investment, which could also accelerate the trend.
4. Policy shifts toward ESG investing
Two-thirds of Americans support more government action on climate. The current administration is making moves to appeal to this public sentiment. Within hours of taking the oath of office, President Biden had signed executive orders moving the US back toward the Paris Agreement and canceling the Keystone XL pipeline. He announced a moratorium on new oil and gas leases on public lands. Addressing the “social” element of ESG, he also issued orders taking action on racial, gender identity, and sexual orientation equity in the US.
Some existing policies are also up for review, such as the US Department of Labor’s rule requiring retirement plans governed by the Employee Retirement Income Security Act (ERISA) to select investments “based solely on financial considerations relevant to the risk-adjusted economic value of a particular investment.” Many investors feared16 that rule could hamper ESG investing—a concern it seems the Biden administration shared. In May 2021, President Biden signed an Executive Order on Climate-Related Financial Risk, which included a directive to identify agency actions that would protect retirement savings.
Though ESG investors have reasons to feel optimistic, they shouldn’t necessarily be preparing for a sustainability utopia. But the Biden administration’s plan to weave climate action across multiple agencies is certainly a promising approach to comprehensive progress.
5. Trend in the making: Shareholder activism
Shareholders are gaining increased access to and direct influence over the direction that companies take in their operations. Across most industries, they’re mounting pressure on companies to prioritize board diversity. Since 2018, public companies in California have had to prove that at least one, two, or three women are on their board, depending on the size of their business.
The trend extends to large, legacy corporations. Goldman Sachs recently announced it won’t execute IPOs17 for companies with all-male boards. Shareholders in oil giant ExxonMobil recently voted to put a third climate activist on their board of directors, a development that bodes well for the future of shareholder activism. If shareholders can get climate action on the agenda of this famously regressive fossil fuel company, what else might they be able to do?
“If shareholders can get climate action on the agenda of famously regressive fossil fuel companies, what else might they be able to do?”
One of the major news stories of this summer was the record-breaking heat that scorched Western Canada and the US. It’s a scary reminder that there’s no end in sight to the increasingly hostile weather events that have defined the past decade. While the COVID-19 pandemic certainly didn’t help matters, international attention on the best definition of “recovery” reveals a rare opportunity to make change. As I look forward to the COP26 in November, I’m optimistic. The United States is back in the Paris Agreement. The EU has proposed a climate tariff. And socially responsible investing just keeps gaining ground.
1: SSRN, From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2508281
2: The Motley Fool, What Is ESG Investing & What Are ESG Stocks?, https://www.fool.com/investing/stock-market/types-of-stocks/esg-investing/
3: Ernst & Young, Sustainable investing: the millennial investor, https://assets.ey.com/content/dam/ey-sites/ey-com/en_gl/topics/financial-services/ey-sustainable-investing-the-millennial-investor.pdf
4: Morningstar, Sustainable Funds U.S. Landscape Report, https://www.morningstar.com/content/dam/marketing/shared/pdfs/Research/Sustainable_Funds_Landscape_2021.pdf
5: Morningstar, ESG Funds Setting a Record Pace for Launches in 2020, https://www.morningstar.com/articles/989209/esg-funds-setting-a-record-pace-for-launches-in-2020
6: Morningstar, Sustainable Fund Flows Reach New Heights in 2021’s First Quarter, https://www.morningstar.com/articles/1035554/sustainable-fund-flows-reach-new-heights-in-2021s-first-quarter
7: Bloomberg, ESG assets may hit $53 trillion by 2025, a third of global AUM, https://www.bloomberg.com/professional/blog/esg-assets-may-hit-53-trillion-by-2025-a-third-of-global-aum/
10: iShares by BlackRock, An Evolution in ESG Indexing, https://www.ishares.com/us/literature/whitepaper/an-evolution-in-esg-indexing.pdf
11: Deloitte, Advancing environmental, social, and governance investing, https://www2.deloitte.com/us/en/insights/industry/financial-services/esg-investing-performance.html
12: Factset, “Record-High Number OF S&P 500 Companies Discuss “ESG” On Q2 Earnings Calls” https://insight.factset.com/record-high-number-of-sp-500-companies-discuss-esg-on-q2-earnings-calls?_hsmi=158096151&_hsenc=p2ANqtz-9MEqH1sWuXkV30vsPhzXFddAgKt3OQTosqQNqWvS9C5Ik6oQlttSfmYsnRskwhMdpRL_tSZ3WM66KKE3a9s8qfS4g5e7llmO0yrPxrnTHTOz5m1sE
13. Blackrock iShares ESG Aware MSCI USA ETF https://www.ishares.com/us/products/286007/ishares-esg-aware-msci-usa-etf
14: Reuters, JPMorgan to buy ESG-focused fintech startup OpenInvest, https://www.reuters.com/technology/jpmorgan-acquire-fintech-startup-openinvest-2021-06-29/
15: PRI, Principles for Responsible Investing, https://www.unpri.org/download?ac=10948
16: Insurance News Net, Industry Group Pans Final DOL Rule On ESG Investing, https://insurancenewsnet.com/innarticle/industry-group-pans-final-dol-rule-on-esg-investing#.X9IypthKg2x
17: Forbes, Goldman Sachs Won’t Take Companies Public If They have All-Male Corporate Boards, https://www.forbes.com/sites/kimelsesser/2020/01/23/goldman-sachs-wont-take-companies-public-if-they-have-all-male-corporate-boards/?sh=69784b99475a
Impact investing focuses on investments in companies that relate to certain sustainable development themes beyond traditional financial factors and demonstrate adherence to environmental, social and governance (ESG) practices. Therefore the universe of investments may be limited and investors may not be able to take advantage of the same opportunities or market trends as investors that do not use such criteria. This could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market.
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