Responsible investing, sustainability and ESG: Debunking the myths
The socioeconomic impact of 2020’s coronavirus pandemic has been gargantuan. But the watershed year has galvanised governments, policymakers and individuals in terms of taking greater action, to ensure we look after the planet and its future.
Notwithstanding the challenges of last year, it appears investors were eyeing a green recovery as sustainability-focused funds attracted more than $51bn in net new money – a new record and more than twice 2019’s total, highlighting how far responsible investing has moved in a relatively short period of time.1
Looking at the current backdrop, AXA IM CIO, Core Investments Chris Iggo says: “Responsible investing is mainstream. Governments, regulators and investors are pushing for even more consideration of non-financial factors in investment decisions. To ignore them means taking risks that could impair financial performance.
“Governments are enacting legislation to promote sustainability, companies are reporting on more environmental and social issues, and investors are driving the allocation of capital to economic activity that contributes to the health of people and the planet.”
AXA Group Chief Economist & Head of Research, Gilles Moëc adds: “The old opposition between supporting economic growth and helping the planet has faded. Governments have harnessed public awareness of the urgency to fight climate change to push through big investment plans which will spur the post-COVID-19 recovery.”
But the rise of responsible investing, and environmental, social and governance (ESG) funds, has come with a fair amount of apprehension. Scepticism can at times still surround these investment strategies, especially in terms of their validity and track record. We examine some of these concerns and showcase the reality.
Myth 1 - ESG is a specialist investment
Governments, consumers and businesses are operating with a greater focus on sustainability, in tandem with increased regulations and targets, including limiting global temperature rises as per the 2015 Paris Agreement goal. To deliver on this aim of keeping global warming to well below 2°C and pursuing efforts to limit it to 1.5°C, carbon emissions need to dramatically fall - and to do this we need to move the global energy sector away from fossil-based fuels, towards greener, renewable alternatives.
Momentum in this area has rapidly picked up; China, the world’s biggest emitter of carbon dioxide, has pledged to become carbon neutral. The US has re-joined the Paris Agreement, and President Joe Biden wants to turn the entire federal vehicles fleet - approximately 650,000 vehicles – green.
In addition, the European Union’s pandemic recovery deal includes some €550bn dedicated to green initiatives – the biggest single climate pledge ever made. On top of this, multinational firms including Microsoft and Google, among numerous others, are now committed to achieving carbon neutrality.
It is no longer a case of moving into the mainstream in the future; ESG looks set to be firmly entrenched as part of the ‘new normal’. In 2015 the United Nations established its Sustainable Development Goals (SDGs), which together aim to end poverty, protect the planet and ensure that all people enjoy peace and prosperity by 2030.2
Post-COVID-19, these global objectives are more vital than ever. Today ever-greater numbers of consumers are demanding greater equality, cleaner energy and better standards of living worldwide. Companies need to rise to this, or risk being left behind – and the same applies to investors.
From an investment perspective, PwC anticipates that by 2025, ESG fund assets under management could account for more than half of total European mutual fund assets by 2025. In its report, The Growth Opportunity of a Century, the group estimates that ESG assets could rise to land between €5.5trn and €7.6trn by 2025 – representing between 41% and 57% of total European mutual fund assets, up from 15.1% at the end of 2019. This would represent a near 29% compound annual growth rate between 2019 and 2025.3
Myth 2 – Responsible investing is only about equities and excluding stocks
The roots of responsible investing lie in stock exclusion, but the concept has since markedly evolved. Initially the way to ensure a portfolio was ‘responsible’ was via stock screening; excluding so-called ‘sin’ sectors such as alcohol, tobacco and gambling as well as industries such as fossil fuels. Typically, this was a trait of equity funds – but responsible/ESG investing can work across asset classes, from equites to green bonds and even in alternatives like commercial property.
Of course, many portfolios still screen out certain areas, but ESG investing is also about looking for firms aiming to do good. For example, many ESG portfolios have a certain environmental or social focus and invest in areas such as clean energy and technology or renewables. Many investment vehicles, such as impact funds, are created with the aim of having a positive societal effect.
Green bonds for example are one such asset. The money raised from green bonds is earmarked for projects around sustainability, mitigation of climate change and other environmental enterprises. But it’s not all about climate and the environment. Our own research has shown that around 25% of green bond investments contribute to a social benefit in areas such as good health and wellbeing as well as work and economic and workplace factors.4 There are also transition bonds which are intended to provide financing for companies which are ‘brown’ today but have the ambition to transition to ‘green’ in future. This includes firms that are not able to issue green bonds today, due to a lack of sufficiently green projects for which they can possibly use bond proceeds.
But beyond asset classes, responsible investing is also about investment firms engaging with companies, to encourage them to align with best practice on ESG issues. This means constructive dialogue and engagement where a company’s approach to relevant ESG matters is below investor expectations and where necessary, leveraging investor rights to push for desired outcomes from investee companies. Active stewardship can promote greater transparency, protect shareholders’ rights and influence better corporate governance. What’s more, engaging with companies on ESG factors can potentially highlight concerns before they materialise and result in fewer undesired surprises which could impact investment performance.
Myth 3 – Investing responsibly means lower financial returns
Historically, the most debated issue about responsible and ESG investing is that it delivers inferior long-term returns, when compared to traditional investment portfolios. This argument is rooted in the early days of responsible investing, that were focused on excluding certain sectors - at the time perhaps potential fertile ground for reliable returns - from portfolios.
But today there is plenty of research which highlights that the incorporation of ESG factors can potentially lead to better performance. One such report concluded that some 90% of 2,200 empirical analyses found there was a relationship between ESG and financial performance – and in the main, this was a positive relationship.5 Additionally, we find the structural relationships between ESG credentials and companies help us assess future profitability and business risk of individual firms.6
Aside from academic research papers, there is proof in hard performance data. The MSCI ACWI ESG Leaders Index consists of large and mid-cap companies from across 23 developed markets and 27 emerging markets - with high ESG performance relative to their sector peers. Since its inception in September 2007, the measure has outperformed the wider MSCI ACWI index on both a cumulative and annualised basis.7
- Sustainable_Funds_Landscape_2021.pdf (morningstar.com)
- United Nations
- 2022 - The growth opportunity of the century - Are you ready for the ESG change? (pwc.lu)
- RI - Green bonds market expected to top the $1trn mark in 2021 - AXA IM Global (axa-im.com)
- Gunnar Friede, Timo Busch & Alexander Bassen (2015) ESG and financial performance: aggregated evidence from more than 2000 empirical studies, Journal of Sustainable Finance & Investment
- AXA IM 2018
- MSCI – as at 29 January 202