One positive to emerge from the economic bloodbath of 2020 was the coming of age of environmental, social and governance (ESG) investments.
The ESG movement had been steadily maturing pre-2020, with 78% of asset owners incorporating ESG into their investment processes by 2019, according to the Global ESG survey of that year. But the Covid-19 pandemic shoved ESG into adulthood as the sustainable investment movement faced a make-or-break moment.
Spoiler alert: it was all make and no break, with US investment giant Morningstar reporting that global investment into ESG funds doubled to US$54.6-billion in the second quarter of 2020 over the first quarter, while ESG bond volumes reached a record high of US$489-billion in 2020, according to data from Refinitiv.
To put all those dollars into perspective: more than a quarter of assets under management globally are now being invested according to environmental (climate change mitigation, energy efficiency, waste management), social (labour standards, human rights, diversity) and governance (board diversity, transparency, closing pay gaps) criteria.
This trend can’t be driven solely by ethically minded investors, so what’s behind ESG’s massive growth spurt?
More government mandates
Governments are increasingly mandating that ESG factors be written into institutional investment policies, partly in a rush bid to meet targets for the United Nations’ sustainable development goals. As an example, mandatory ESG reporting requirements have increased to 600 globally, a jump from 383 in 2016 when the goals were introduced.
Europe has been the frontrunner in making sustainable investment compulsory for state-run pension funds, whereas under Donald Trump’s neoliberal capitalist, climate-denialist rule the United States lagged far behind, but this is set to change under President Joe Biden’s administration.
Asia was also lagging behind, with Japan being the exception by signing the Principles for Responsible Investment for its government pension fund in 2015. Now, in a promising move, China is set to follow suit after its government committed to achieve carbon neutrality before 2060, which would necessitate government-mandated ESG investment principles.
Closer to home, South Africa’s Financial Sector Conduct Authority issued a guidance note in 2019 stating retirement funds need to write ESG accountability into Investment Policy Statements.
The climate crisis
The climate crisis is driving an extraordinary increase in new funds with an environmental focus. In the third quarter of 2020 alone 27 new environmental funds were launched.
“This high level of product development is unprecedented, spurred by European regulation, which aims to divert even more money into sustainable products to meet Europe’s Paris Accord targets,” Morningstar reported.
With Biden moving to reverse Trump’s withdrawal of the US from the Paris climate agreement just hours into his presidency and his administration simultaneously rolling out a fleet of executive orders to tackle the climate crisis, we can expect to see an exponential growth in environmentally driven funds this year.
Sustainability-driven millennials
Eco-conscious millennials are the vanguard of the ESG investment movement. Man-bun jokes aside, millennial investors need to be taken as seriously as the economic clout they’re beginning to wield.
According to a recent Morgan Stanley Capital International (MSCI) report, millennials account for 23% of the global population and are now entering or already in their prime earning years. They are becoming the beneficiaries of baby boomer family benefactors with analysts predicting that more than$30-trillion is already being transferred into the hands of millenials.
This group has the economic power to shape investment trends and data shows they’re prioritising ESG investments, with millennial interest in ESG rising from 84% to 95% between 2015 and 2019, according to MSCI’s Swipe to Invest: The Story Behind Millennials and ESG Investing report.
A recent report from S&P Dow Jones Indices found that baby boomers and generation Xers are also increasingly aligning investments with their values, provided this does not jeopardise investment performance.
The Covid-19 pandemic
Here’s the big one: Covid. With economies in tatters because of the pandemic, policymakers and investors are viewing the Covid crisis as a wake-up call to prioritise sustainable investing.
A JP Morgan poll of investors from 50 global institutions found that 71% believe it is likely or very likely that the pandemic will increase awareness and actions globally to “to tackle high impact/high probability risks such as those related to climate change and biodiversity losses”.
As Gill Lofts, the Europe, the Middle East, India and Africa sustainable finance leader at EY in the United Kingdom, wrote: “What Covid-19 has done is show acutely how a sustainability crisis can impact economies, businesses and society at large. It is an example of what could happen were we subjected to further sustainability shocks. That doesn’t have to be climate change.”
As lockdowns, retrenchments and stressed working conditions gripped the world in 2020, it became clear there is a dire need to focus more on the S in ESG: social sustainability in the form of better labour standards, employee health and safety, pay and benefits. This led to the unusual situation whereby some major shareholders urged companies to focus on employee well-being, even if this resulted in cutting dividend payments.
Diversity came to the fore with the Black Lives Matter protests in the US, leading investors and ESG rating agencies to put pressure on companies to improve diversity tracking and reporting. A recent survey of institutional investors by US consultancy firm Edelman reported that 72% are putting portfolio investments that do not meet diversity and inclusion thresholds on watchlists.
Fertile performance conditions
Growing government regulation, a sustainability driven economic group coming into their prime, the climate crisis and Covid combined in 2020 to create fertile conditions for ESG to assert itself in the market. And it’s done just that, not only weathering the economic storm but outrunning it.
In a study of more than 2 600 companies, Fidelity International found that stocks with higher ESG ratings outperformed those with weaker ESG ratings in every month from January to September 2020, with the exception of April.
Meanwhile, S&P Global’s analysis of 17 exchange-traded and mutual funds that select stocks based on ESG criteria found that 14 posted higher returns than the S&P 500 from January to July 2020.
Investors follow the ESG money
ESG funds’ general resilience and outperformance in 2020 has spurred major fund managers to ramp up their ESG investments.
BlackRock took the lead in the US by announcing that almost all of its $7-trillion assets under management would be governed by ESG considerations. BlackRock chief executive Larry Fink said the move was made not only to provide investments that reflect clients’ values, “but also to enhance performance, risk management and portfolio construction”.
This was followed by the launch of the Net Zero Asset Managers initiative, a collection of 30 of the world’s largest asset managers setting a goal to achieve net zero carbon emissions across their portfolios by 2050.
In South Africa, Sygnia is on trend with the launch of its new Sygnia S&P Global 1200 ESG ETF.
One of several new ETFs (exchange traded funds) being introduced by the asset management firm, the Sygnia Global 1200 ESG ETF enables South Africans to invest consciously with ease, and expect higher returns as the fund tracks the S&P Global 1200 ESG, which has a similar exposure to the MSCI World ETF but includes diversified and emerging market stocks with an ESG element.
All in all, the outlook is clear: environmental, social and governance investment is hitting its prime, making the future of investing a lot brighter, cleaner and sustainable.