High headline inflation was driven by the war in Ukraine and the accompanying energy and food price rises, prompting central banks to raise interest rates. None of this was any good for sustainable strategies, which tend to be invested in growth-oriented companies, and less so in the energy, materials, and value stocks that did well in this crisis.
Many said this spelled the end of the growth we have enjoyed in sustainable investing — in fact, it’s more of a short-term hiccup that, like all hiccups, will eventually pass.
Let’s be honest though — sustainable investing did face some clear challenges in 2022. First of all, the energy crisis brought a dash back into fossil fuels and even into thermal coal as gas prices soared, partly due to sanctions against Russia. The energy sector saw strong performance while growth stocks lagged, as sustainability took a back seat as investors took a “needs-must” approach.
There has also been a backlash on sustainable investing, particularly in the US. ESG has become very politicised, with the anti-ESG movement making the most noise. The direct impact of this movement was limited to state-funded investment assets in the Republican states where anti-ESG sentiment was prevalent. The majority of investment strategies were not impacted directly, but more indirectly through reputation and political association. This effect should probably not be underestimated.
Additionally, greenwashing is now seen as an even bigger risk, as some large asset managers have been accused of overstating their sustainable investing credentials. This has led to some of them retracting support for global initiatives like the Net Zero Asset Manager alliance. But it also led to “green bleaching” (a.k.a. grey washing) which conversely means understating the genuine sustainability credentials of investment strategies. That’s not a good development either.
Lastly, new regulation in the EU has placed the burden of proof of how sustainable an investment product is on the strategies and mandates themselves, whereas those investment products that do not attempt to integrate ESG have much less work to do. It hardly seems fair.
Three long-term drivers
Sustainable investing is, however, clearly supported by three long-term drivers. First of all, sustainability issues — most notably climate change — have become increasingly financially relevant for companies, and thus, investors. Business processes and end markets are affected by the success of the introduction of sustainable alternatives for traditional non-sustainable ones.
This can be seen in electricity generation, for example, thanks to the growth of renewable energy sources, but also in the car and food industries. In fact, most industries are now affected by sustainability in some way, whereas 10 years ago, investors might have ignored it. These days, ignoring it is no longer an option.
Clients’ and society’s standards on and expectations of how the financial industry handles sustainability issues are rising. A recent study showed not only is climate change already central to investment policy by seven out of 10 institutional investors, 66 per cent believe biodiversity will be a significant or central factor in their investment policy over the next two years, compared to 48 per cent saying this is the case today. That’s a massive rise from the 16 per cent for whom it was significant, and five per cent for whom it was central, two years ago. Implementation of those policies is still in its infancy, but it is very clear that asset owners will put pressure on their suppliers to implement these issues into investment strategies.
Where regulation can help
Another long-term driver is regulation. The EU is setting the example and Asia and Latin America are following suit. Even though the backlash on sustainable investing in certain US states is generating lots of media attention, federal legislation is moving to support ESG.
The Securities and Exchange Commission will release its final rules on corporate climate disclosure by the end of this year, at the latest. The objective is for investors to get more information about corporate climate-related risks that are likely to have a material impact on their business. The new corporate disclosures will be a first in the US; importantly, they are likely to require that corporates report on greenhouse gas emissions and impacts to line items on companies’ financial statements from climate-related risks.
So, ignoring or not implementing sustainability is no longer an option for most institutional investors. Depending on where their clients are in their sustainability journey, they are gradually integrating material ESG issues into investments, implementing their own views on sustainability, and exploring ways to further advance towards having real-world impact.
Client interest remains high. Even in these challenging times, sustainability as a topic remains firmly on the agenda for clients. And looking towards an even shorter time period, in Q1 2023, we saw that ESG performance had improved globally, and fund flows were still outperforming traditional strategies.
During my two decades of involvement in ESG integration and sustainable investing, we have always seen periods of short-term volatility — all of which were overcome. Therefore, my conviction remains as strong as ever. Sustainable investing is riding the waves of the financial markets and is here to stay.
Masja Zandbergen, head of sustainability integration, Robeco
