The rise of ESG investing

Sustainable investing used to be a niche part of the market, but post-pandemic it seems that looking at the environmental and wider ESG (Environment, Social and Governance) impact of one’s portfolio has become increasingly mainstream.

UK investors put around £1bn into funds focusing on these investments every month in 2020, and they now represent 4% of all funds under management, with Chris Cummings, chief executive of the Investment Association, saying that these funds “continue to capture investors’ imagination”.1

Why is green now good? Partly it is to do with a growing concern that many of us share about how our actions affect the climate we live on, but it is also just good sense, given the way that sustainable assets have performed in recent months.

A clean, green, profit machine?

Sustainable funds have had a good pandemic. Whether in the UK or further afield, investment funds focused on ESG concerns outperformed much of the market in 2020.23  

That’s partly to do with what these funds don’t contain, in particular stocks focussed on oil prices, which tanked during the early days of the pandemic, as well as those involved in foreign air travel. 

These funds also tend to focus on technology stocks, which did well during 2020.

Recent analysis from investment bank UBS also found that its low carbon investment strategy, which focuses on the 50% of stocks with the lowest carbon intensity in each sector and region, would have outperformed the benchmark by nearly 0.9% every year.

The bank thinks that the outperformance is due to a number of factors, including the increasing taxes and fines for carbon emissions, growing interest from investors and the fact that these firms may be more efficient and this may be reflected in their different emissions as well as higher profits.4

What’s happening now?

If green has been good in the ‘crisis’ phase of the pandemic for the Western world, there now seems to be some rebalancing.

Figures from Trustnet, which looks at how funds and their constituent parts perform, found that three-quarters of sustainable funds underperformed their average peer in the first quarter of 2021.5

This partly reflects a shift in the types of business that have done well in terms of share prices. 

In recent months, we have seen a shift towards the types of stocks that benefit from the world opening up, such as restaurants, hotels and airlines, and that has benefited less obviously ‘sustainable’ businesses.

In the short term, then, green investors may find that their stocks do not perform quite so well as in recent months.

Next green steps

Investment should be for the long term, and although the ‘green bounce’ may have stalled a little in recent months, long-term trends would seem to benefit companies that seek to become more carbon efficient and work in sectors that will grow due to increased demand for green energy and efficiency.

Conversely, those companies that do not incorporate strong ESG controls into their businesses are likely to face fines and investor disapproval as requirements to report adherence to ESG principles grow around the world.

It will be easier than ever to check ESG records on investments in the coming years. For example, the Association of Investment Companies is now asking its members to share their ESG policies due to “growing demand from investors for information on ESG criteria and policies”.

Green investment can be complex, as there is no official definition for “sustainable” or “environmental”. If an individual wants to ensure their investments are held in line with sustainable principles, the most important thing to do is to ensure one understands the underlying holdings of the funds invested in, and the mandate that the investment manager holds to invest one’s money.

4. Source: UBS Global Research Q-Series Carbon investing: does a lower carbon intensity portfolio sacrifice return? May 3, 2021