Investment vehicles with Environmental, Social, and Governance (ESG) goals have taken a new spotlight in recent months following ongoing volatile market conditions and widespread macroeconomic turmoil driven largely by the pandemic and political instability.
Until more recently, investors and fund managers showed little interest in variables relating to companies’ environmental impact and carbon footprint, human rights violations, top-level management performance, or consumer data and information privacy.
Shifting market trends, coupled with the rising demand for more progressive climate policies and transparency, have led an increasing number of retail and institutional investors to throw their weight behind ESG-focused investment opportunities.
While ESG-related investments are poised to experience steady growth in the coming years, there is a sense of skepticism clouding ESG-based investment vehicles, prompting many to consider its resilience amid volatile market conditions.
A recap of ESG
While the theoretical assessment of ESG has been around for over a decade, it wasn’t until the mid to late 2010s that widespread interest started to take off strongly.
The market share of ESG-focused investment vehicles and funds globally grew from $11.35 trillion in 2012 to more than $30.7 trillion by 2018.
At the turn of the decade and the advent of the COVID pandemic, ESG investments started pulsating at the seams. In 2021, more than $120 billion was poured into sustainable investments, setting a new record and doubling from the $51.1 billion invested in ESG funds in 2020.
It’s not surprising anymore that analysts at Bloomberg predict that by 2025, global ESG assets are set to exceed $52 trillion, which will, in total, represent more than a third of the $140.5 trillion in estimated total assets under management (AUM).
The combination of national policies, consumer demand for more transparent and climate-conscious corporate practices, and increased levels of accountability have all attributed to increased ESG-related investment products available to retail and institutional investors.
In fact, these investments have already exceeded $1 trillion, and continuous support has given it a bigger platform through which it can solidify itself.
The development of more inclusive capitalism gives investors two ends of the same stick. The importance here is that investors now see companies that perform well on ESG are more resilient against economic and market downturns, such as seen during the pandemic, and are well-prepared for long-term growth and uncertainty.
The significance of Environmental, Social, and Governance issues have become key factors for investors, partially due to mounting pressure coming from the national government and the increasing importance of portfolio decarbonization.
Following a 2020 EY Climate Change and Sustainability Services (CCaSS) Institutional Investor survey, the outcomes thereof speak for themselves.
The survey concluded that nearly 98% of investors currently assess ESG metrics when applying themselves to new investment opportunities and funds. A further 72% of survey respondents said that they carried out a structured review of all ESG performance metrics beforehand.
When we compare these figures to a similar survey conducted only two years before, we see that the same number (72%) was substantially lower, with only 32% of investors claiming to commit to some structured ESG review.
With ESG-focused investments and funds taking a more dominant place on the world stage and the global investment market, further assessment could indicate that a growing number of investors will plan to have a more rigorous regime and assessment strategy when it comes to ESG-focused assets and investment opportunities.
A restructured strategic approach
With a growing number of investors from all corners of the global economy aligning their portfolios towards better ESG performance, the interest signals a new approach to solidifying restructured strategic development for responsible funds.
Instead of seeing ESG-related investment as a growing opportunity to drive inclusive capitalism, investors are taking a more fundamental approach that identifies ESG issues as an elementary performance indicator.
With this in the spotlight, companies and businesses that operate under an ESG framework are creating a standing impact to address key issues within the global economic ecosystem. This, in turn, translates into action that can ensure investors with long-term success, which not only drives investor interest but gives a more impactful consumer preference.
Research by McKinsey showed that organizations that pay attention to ESG concerns could increase their returns and overall top-line growth. The research found that of more than 2,000 different studies, 63% had positive returns, while only 8% had negative returns.
Furthermore, it was shown that organizations that are more focused on ESG concerns could reduce costs, witness an increase in productivity, have optimized investments and assets, and have more progressive regulatory and legal interventions. On top of this, organizations also see an overall improvement in their top-line performance as they undertake more ESG-focused metrics.
These are valuable assessments that investors, in this case, those more concerned about environmental issues, social justice, and corporate governance, take into consideration when developing their strategic investment approach.
What’s more, it can be considered how companies that use improved ESG practices can increase and provide long-term efficiencies that help them counter rising operational costs, lower their capital expenditure, and increase the company’s overall value.
When we start tying the ends together and look at how these metrics develop a more concrete performance for companies, not just for increased consumer preferences and national policies, companies can deliver value to their stakeholders, which typically includes solidified financial returns.
The ESG framework brings new metrics into consideration that helps retail and institutional investors make more informed decisions based on critical and first-hand assessment.
Although many investors consider their interest in ESG purely based on the amount of capital or financial return, the near-term investment and capital directed to these companies only further solidify the attraction of cleaner business operations and improved social and corporate governance.
ESG weathers downturns
Although it’s possible to see that stakeholder interest and capital support for ESG-concerned investments and funds have increased over the last couple of years, looking at overall performance against the backdrop of sinking economic conditions is what concerns many investors.
Seeing how these stocks and typical funds have managed to weather downturns against non-ESG vehicles helps to paint a better picture of the long-term success these investments can provide investors.
Following the Morgan Stanley Institute for Sustainable Investing report, outcomes showed that ESG funds in bonds and stocks performed substantially better than non-ESG portfolios during volatile market conditions.
The report showed that sustainable equity funds outperformed typical peer funds by 4.3% in 2020. This research was conducted on more than 3,000 U.S. mutual funds and Exchange-Traded Funds (ETFs) in 2020.
Further down, the study also managed to prove that sustainable bonds in the U.S. performed 0.9% better than regular bonds.
Overall the median downside deviation of sustainable equity funds was 3.1% lower than typical peer funds, while sustainable taxable bond funds were 0.4% lower than traditional peer funds.
Other research shows that since the S&P 500 ESG Index was launched back in 2019 until the end of 2022, the index has managed to outperform its benchmark, the S&P 500 Index by 9.16%.
The index saw the same thing happening during the pandemic years when market conditions fell to record lows, and overall investor sentiment decreased. Between 2019 and 2021, the ESG index outperformed the normal S&P by 3.7%.
It’s important to mention that the pandemic and economic repercussions were major driving forces for improved profitability of sustainable investing.
The MSCI ACWI Index, which measures large and mid-cap equity market performance across 23 developed markets and 24 emerging markets, measured a similar increase in four ESG indexes to the benchmark MSCI ACWI.
Overall, it showed that during market volatility and widespread economic downturn, ESG indexes managed to weather these conditions and still outperform their non-ESG peers.
There are standouts within the category that proves to stakeholders and fund managers that ESG investing is not only a sustainable opportunity but delivers more buoyant performance during turbulent conditions.
The greater impact thereof has been reflected in how the organizations in the ESG category are relatively more sufficient despite having to navigate stringent market conditions, labor shortages, increased interest rates, and a slowdown in consumer spending.
While the ESG framework, which in reality is starting only to see itself mature in more recent years due to the ongoing impact-driven investing opportunities it’s presenting to many stakeholders, there remain areas where systems can be improved and modified to enlarge the scope of effort ESG portfolios are making in the larger scheme of things.
The verdict
As investors continue to throw their weight behind ESG-concerned companies, funds, and investment opportunities, so will the performance thereof see greater growth despite navigating an increasingly volatile market environment.
The bottom line is that environmental, social, and governance-oriented investments can outshine underwhelming conditions purely for the fact that ongoing regulatory frameworks and increased demand for sustainable business operations are driving investors to decarbonize their portfolios further.
However, it’s worth mentioning that although these investments present fundamental financial returns to stakeholders, it does encapsulate a broader, more progressive, and considerably sustainable capitalist market that seems to be thriving even during unsettling times.
