Responsible investing has moved from niche to mainstream, with investors increasingly seeking to support the green transition at the same time as profiting from it.
Peter Smith, investment director with Aviva Investors, says the demand for environmental, social and governance (ESG) investments has exploded over the past few years, with quarterly flows growing from around $20 billion (€18.8 billion) at the start of 2017 to a peak of $160 billion at the end of 2021.
“Whilst 2022 was a challenging year for all investment funds, sustainable solutions still proved to be amongst the most resilient, taking in $37 billion in net flows whilst the overall global fund universe suffered outflows of $200 billion during the last quarter of the year,” says Smith. “The size of the global ESG investment market has more than doubled over the past three years, now representing $2.5 trillion in assets under management.”
That growth has at least in part been driven by strong returns. “Over the last decade or so we have seen big investment flows into strategies that either purport to be or are sustainable,” notes Ian Quigley RI, head of investment strategy with RBC Brewin Dolphin Ireland. “Up until last year, ESG-focused strategies did quite well and outperformed the market.”
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An element of that outperformance was due to the popularity of those funds. Strong demand from investors drove capital inflows and pushed prices up. But there were other factors at play as well.
“If you look a bit deeper at why the strategies outperformed, the companies that screened well tended to be less capital intensive,” says Quigley. “Tech companies also tended to do well on screening. And there was a style bias towards growth. Last year saw a change, with a lot of sustainable strategies underperforming. The interest rate shock and the energy crisis meant that the oil companies were among the few that did really well.”
Green investments’ growth opportunities are likely to be realised earlier as the pace of the energy transition accelerates across all regions
— Suzanne Keane
Davy chief investment manager Donough Kilmurray has seen growth in both supply and demand. “There has been massive growth in both areas. Supply has gone up because investment managers want to give their clients what they are looking for,” says Kilmurray. “In demand terms, Davy always had a large number of clients such as religious congregations who had ethical considerations for their investments and that is now spreading.”
Looking at the picture for returns, Kilmurray points out that the focus on tech-oriented, less capital and resource-intensive companies was great up until last year. “The war in Ukraine came and suddenly old economy investments became good again. There was a decade of outperformance with new economy investments but that flipped the other way last year.”
However, there is broad agreement that this is not a long-term trend. “In our view, a key takeaway from the performance of green investments in 2022 is the importance of a diversified, more inclusive approach in building balanced portfolios which do not display an excessive growth bias and go beyond just selecting the best-in-class ESG companies,” says Suzanne Keane, senior equity solutions portfolio manager at Amundi. “We also believe that investing in businesses at an earlier stage in their sustainability journey, businesses which are showing improvement in their ESG ratings, is critical in pursuing consistent risk-adjusted returns. Indeed, these companies may be the ESG winners of tomorrow.
“Looking forward, we regard the recent headwinds for green investments to be largely transitory in nature,” she continues. “Green investments’ growth opportunities are likely to be realised earlier as the pace of the energy transition accelerates across all regions, including the EU and Ireland. Indeed, a huge wave of fiscal incentives is coming down the track, including the recent introduction of the EU’s Green Deal Industrial Plan, designed to boost the competitiveness of net-zero industries. This was closely followed by €250 billion being made immediately available for member states to offer tax credits and subsidies for investments in areas such as batteries and wind power.”
That growth is mainly a European phenomenon, however. “Despite impressive growth, ESG investing is not being adopted at the same rate across regions,” Smith points out. “Europe is still the biggest market for sustainable funds, responsible for 83 per cent of global assets under management (AUM). Sustainable investments now account for 20 per cent of European AUM, with this percentage expected to rise even further as additional products are launched. The US has been a laggard in terms of uptake, making up only 11 per cent of sustainable AUM and an even smaller proportion of recent flows. The conversation there has been plagued with anti-ESG sentiments, with some politicians going as far as limiting state investment funds from doing business with ESG-conscious asset managers.”
Kilmurray believes this imbalance will even out over time. “There is a bit of pushback in the other direction, particularly in the US – and that is the biggest investment market out there. But Europe seems content to remain a leader in sustainability standards. Ultimately, this is the direction world is going in. America will get there in a while.”
Ibec head of social policy Kara McGann believes there are more fundamental drivers behind the growth in responsible investing. “We are in a bit of a perfect storm, with more and more companies focusing on ESG and sustainability and recognising their importance both to their own businesses and to their stakeholders,” says McGann. “Employees and potential employees and consumers are increasingly focusing on the space. Companies are seeing the benefits in terms of increased efficiencies in operations and processes, waste reduction and innovation in products and services all delivering long term value for the business. All of the research points to increased ESG focus leading to greater operational performance.”
McGann believes this will become the norm for all businesses in time. “We are seeing a groundswell coming from the companies themselves,” she says. “They are pulling in the same way as their investors and customers. That’s great to see. We are coming to a stage where if companies don’t take it seriously and simply treat it as a tick-box exercise they will be found out very quickly. But there is no one-size-fits-all solution. It depends on the company and sector involved. What is material for one company in ESG will be different for another. There is no off-the-shelf approach. This is something Ibec is focusing on with its members and it’s great to see the investment community focusing on it as well.”