Recent challenges have pointed towards elevating challenging in the battle against climate change on a socio-economic level. With political unrest and instability emerging as a global challenge, the outlook for Q4 remains volatile.
With that being said, investors are particularly focusing on sustainable investments to protect their portfolios against the impacts of recent event. To address these concerns,
To address issues of climate change and socio-economic concerns effectively, governments and companies will need to drastically change how they operate, and investors can influence how they do so. Investing in sustainable enterprise can be chosen by everyone – from the largest asset managers to the smallest individual investors.
As mentioned earlier, investments are no longer solely selected based on their ability to generate financial returns. It is important to investors that sustainable solutions reflect their values, contribute to the important missions they care about, and do no harm to the environment. In response to this grassroots shift, sustainable investing is on the rise. There is also an expanding selection of products available, giving investors a choice regarding how much positive impact they want to make. At one end of the spectrum, investments in harmful activities like tobacco and coal are excluded, as are controversial behaviors like human rights abuses. On the other hand, dedicated impact strategies seek to identify companies that contribute directly to the UN’s Sustainable Development Goals.
It is common for investors to cite improved returns as a top motivation for implementing ESG criteria, and investment managers often promote sustainable investments as offering superior returns. Additionally, environmentally friendly stocks have outperformed those at the opposite end of the environmental spectrum over the past decade. But what other factors account for the popularity and rise of sustainable investments?
Why Sustainable Investment Is on the Rise
A stronger focus on sustainable investment most recently has been prompted by current economic volatility, such as the recent inflation spike partly caused by the recent war in Ukraine. In fact, the war in Ukraine is driving that debate forward, not because of climate change, but because Europe needs to be more independent when it comes to energy provisioning. The fundamentals for fossil fuels are worse in the long run, while renewables are better. Allied Market Research points towards how it is expected that the global sustainable finance market will grow as investments in businesses with sustainable practices increase. Sustainable financing offers remarkable perks such as risk mitigation, cost cutting, and higher returns, and green energy projects become more prevalent.
Based on Allied Market Research’s report, the global sustainable finance market is forecast to reach $22,485.6 billion by 2031, growing at a CAGR of 20.1% from 2022 to 2031. Among the topics covered in the report are top winning strategies, evolving market trends, market size and estimations, value chain, key investment pockets, drivers & opportunities, competitive landscape, and regional landscape. It is a valuable source of information for new entrants, shareholders, frontrunners, and shareholders in introducing necessary strategies for the future, and taking crucial steps to significantly strengthen and heighten their market position.
What’s in it for Investors?
In April 2010, the Deepwater Horizon oil drilling rig exploded, resulting in the world’s worst maritime oil disaster. BP was quickly identified as the culprit. BP has been forced to pay roughly 65 billion US dollars in penalties and settlement payments as a result of the court’s ruling, or around 58 billion euros in total. The environmental catastrophe also had a devastating effect on investors: The BP share price fell by around 50% between April and June 2010, and has yet to recover fully. Risks have been reassessed by investors using ESG criteria after cases like the Deepwater Horizon. The acronym ESG stands for Environment, Social, and Governance. Loss risk was therefore the key focus. This question has been brought to the fore by the American index provider MSCI: What are the direct financial benefits of sustainable investment for investors? Some of the conclusions in the study included:
- The Deepwater Horizon incident clearly illustrates how companies with good ESG ratings have a lower risk exposure. Among the reasons for this may be more stringent risk monitoring methods. BP was therefore omitted from MSCI’s sustainability index shortly before the rig disaster in early 2010.
- High dividends and profitability are the results of a good sustainability rating. As an example, the ESG-dominated emerging market index MSCI EM ESG Leaders has grown by 179.52 percent between 2007 and 2019, while the traditional MSCI EM has grown by 118.93 percent. Why? In addition to attracting a more talented workforce and retaining a positive organizational culture, companies that follow a sustainable strategy are more future-oriented and future-oriented, among other factors.
- Another MSCI survey demonstrated that improving an ESG rating significantly boosts performance. The index provider compared factors such as the long-term performance of companies with improved ESG ratings with that of companies with deteriorated ESG ratings. In a nine-year analysis of industrialized nations, the growth for companies in the first group was 12 points higher than for those in the second group.
Investors who compare mutual funds with similar performance still worry that one with a sustainable investing model might not perform as well. Recent insights from the Morgan Stanley Institute for Sustainable Investing show that worry is unfounded. Investors can expect similar returns from sustainable funds while having lower downside risk, and making a positive impact on a range of environmental, social and governance concerns. In spite of research showing that companies with strong social or environmental practices outperform their peers on a wide range of measures, the myth that sustainable investing requires a financial trade off continues to persist. According to their study of thousands of mutual funds across a variety of asset classes, sustainable investments can help investors manage risk and generate returns.
As part of its white paper, “Sustainable Reality: Analyzing Risk and Returns of Sustainable Funds,” Morgan Stanley analyzed 10,723 exchange traded funds and open-ended mutual funds active between 2004 and 2018. Here is what was found:
- Sustainable funds and traditional funds do not have any financial tradeoffs. The total returns of ESG-focused mutual funds and ETFs did not differ consistently or statistically significantly from those of traditional mutual funds and ETFs.
- There may be a lower market risk associated with sustainable funds. A consistent and statistically significant finding is that sustainable funds have a 20% lower downside deviation than traditional funds.
The study found that sustainable funds’ downside deviations were significantly smaller than those of traditional funds during years of extreme volatility, such as the one we are in currently. Additionally, the study analyzed the last quarter of 2018, when U.S. stock market volatility spiked, and found that, despite negative returns for most funds, the median sustainable fund outperformed the median traditional fund by 1.39 percent in U.S. equity returns and had a narrower dispersion than the median traditional fund. The last quarter of 2018 may have caused anxiety among many investors, but those with investments in sustainable funds will likely have experienced smoother fluctuations and fewer losses.
The fact that 53% of investors believe investing sustainably requires a financial tradeoff may surprise 59% of millennial investors. However, from both a financial and impact perspective, incorporating ESG criteria into investment decisions makes sense. Individual investors expressed 75% interest in sustainable investments in a 2017 survey conducted by the Institute for Sustainable Investing, and the Forum for Sustainable and Responsible Investments (US SIF) reports that one-fourth of all dollars invested in U.S. capital markets include sustainability. Investing interest and adoption gap can be narrowed with the latest findings from Morgan Stanley.
Interviews with institutional investors as part of a McKinsey study revealed a wide range of reasons they pursue sustainable investing. There were three reasons that were recurring.
- Increasing returns: In general, sustainable investing appears to have a positive effect on returns. A growing body of research explores the relationship between ESG performance and corporate performance, as well as the relationship between ESG investment strategies and investment returns. The correlation between sustainable investing and superior investment returns has been demonstrated in several studies. Sustainable investing is not correlated with poor returns, according to a recent comprehensive study (based on more than 2,000 studies). As a result of the other motivations outlined below, sustainable investing has provided convincing grounds for investors to pursue sustainable investment strategies – particularly in light of the likelihood that sustainable investing produces market-rate returns as effectively as other investment approaches.
- Improving risk management: A company’s market value and reputation can be impacted by ESG issues, according to institutional investors. As a result of worker safety incidents, environmental pollution spills, supply-chain disruptions linked to weather, and other environmental issues, companies have seen their revenues and profits decline. Several companies’ brands have been damaged by ESG issues, which can account for a significant part of their market value. Furthermore, investors are questioning whether firms are prepared for long-term trends like climate change and water scarcity, which are posing risks to their survival.
- A strategic approach that aligns with beneficiary and stakeholder priorities: Investors have developed sustainable investing strategies in response to demand from fund beneficiaries and other stakeholders. Public attention to the global sustainability agenda has led to this increase in demand. Younger generations seem to be particularly interested in sustainable investment strategies. In a survey of high-net-worth millennials in the United States, two-thirds agreed with the statement, “I invest to express my values about society, politics, or the environment.” The same belief was expressed by more than one-third of high-net-worth baby boomers, a significant proportion given that baby boomers constitute the largest constituency for institutional investors. The goal of some investors is to help society by investing in companies that have favorable environmental, social, and governance (ESG) features (without compromising risk-adjusted returns.
Current Scenario in the Sustainable Investment Industry
Since evidence has accumulated about sustainable investing’s benefits, the sustainable investing market has grown significantly as demand has surged for sustainable investment strategies. Sustainability investing strategies are being adopted by some of the world’s leading institutional investors. Regardless of their starting point, most large funds are trying to develop sustainable strategies and practices. Despite the fact that some institutional investors struggle to define their approach and to make good use of ESG information and insights, studies and research in collaboration with institutional investors indicate otherwise. Institutions already use methods to select and manage portfolios that are complementary to sustainable strategies, and close integration can have significant benefits for both.
In a recent study by global wealth and asset manager Lombard Odier, sustainable investments have become a bona fide investment opportunity for Asia-Pacific’s richest investors, but a generation gap and a lack of quality investment opportunities remain obstacles to growing sustainable investment. Thailand and Taiwan lead the region in channeling funds to sustainable investments, with nearly all respondents from both countries stating they invest in sustainable assets, while about one third have portfolios that contain at least 40 percent of sustainable assets, according to Lombard Odier’s 2022 HNW Individuals Study. This year’s study includes more than 450 responses from high-net-worth individuals in eight countries, namely Singapore, Hong Kong, Australia, Japan, Thailand, the Philippines, Indonesia, and Taiwan. Lombard Odier said in a statement today that sustainable investments are becoming more prevalent, and that value-driven investments are being replaced by real anticipations of returns.
There has also been a rapid growth in assets in sustainable mutual funds and exchange-traded funds (ETFs) in recent years. During the period of 2020 to 2021, assets in these funds increased by 52 percent to $362 billion. According to Broadridge Financial Solutions, ESG assets could reach $30 trillion by 2030. As per another study published in European Business Organization Review, recent years have seen a surge in capital flowing into funds that practice sustainable investing, reflecting an increased investor awareness of environmental, social, and corporate governance issues. Globally and in specific markets, such as the U.S. and Europe, capital is increasingly flowing into sustainable investments.
The Outlook for Sustainable Investment in the Near Future
In the coming years, ESG investment is expected to grow enormously because of several factors: millennials’ increasing demand for investment opportunities that meet specific social or environmental objectives, improved methodologies that confirm that sustainable-investment criteria are being followed, and new legislation that promotes the creation of ESG investment products and requires greater transparency. Investing in ESG criteria that includes both financial and non-financial aspects will now be more feasible for individual investors. Therefore, investors can contribute to sustainable development and positive social impact as well as make money by rewarding companies and institutions that meet ESG requirements.
With climate change becoming more prominent, corporations are being pressured to do their part to combat global warming. There is a growing movement among the world’s largest companies to produce net zero carbon emissions, and many are urging others to follow their example. A number of major companies, including Amazon and IKEA, are pushing for the ocean shipping industry to switch to carbon-free fuels by 2040. In response to climate change risks, investors are also pushing companies to be more transparent. Many factors contribute to long-term investors staying the course. Biden administration’s agenda (and many governments world wide’s, as well) focuses on climate change to drive new corporate policies. Additionally, the recent economic turmoil faced all over the world has helped highlight social injustices. Due to this, socially and environmentally conscious investors are likely to demand more from companies.
According to J.P Morgan, sustainable investing has transformed from a niche investment sector and become an essential component of balanced portfolios. It has penetrated so far into the mainstream that PwC Luxembourg’s first European Sustainable Finance Series report predicted 2022 as the year when traditional and sustainable investments could subside significantly. In other words, they predicted that both financial and non-financial performance criteria could be on equal footing when making an investment decision due to the urgency of the climate crisis. This sort of claim is only going to grow in the coming years. According to the report, the Asset and Wealth Management industry should jump on board and embrace sustainable investing. As an investor, this means prioritizing both your values and financial goals.
ESG standards and evaluations have become increasingly important from an investment perspective, especially after the war in Ukraine. Those companies that plan ahead and prepare for the possible risks associated with climate change may be able to respond more effectively when they are realized.