Three factors set to drive appetite for sustainable equities

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Sustainable equity investing has taken off in recent years, as investors put their capital to work to address the climate crisis and social injustice. Three fundamental factors are fuelling this expansion: strong investor demand, the global sustainable development push, and ambitious new regulations. With key climate deadlines looming, the growth of sustainable equity strategies is poised to accelerate over the next decade.

Sustainable investing is not new. It started as a niche activity but has become mainstream due to the signing of the Paris Agreement and the adoption of the United Nations’ Sustainable Development Goals (SDGs) in 2015. These initiatives spurred governments and companies into action on climate change and economic inequality.

Surging investor demand for sustainable investing products has been the motor driving expansion of the market in recent years, and 2021 was no exception. Investors poured more than USD 600 billion into sustainable funds worldwide last year, with equity remaining their asset class of choice, according to data compiled by Morningstar.[1]

The momentum has continued in the first quarter of 2022, even as financial markets were rocked by inflationary pressures and market turmoil stemming from the war in Ukraine. While inflows slipped by about a third from the previous three months, they held up far better than those of the overall fund market, which saw a 73% decline, Morningstar data show.

Regulation

Regulation has also been a key driver in the development of sustainable equity investing by requiring companies and asset managers to publish greater details about their operations impact on the planet as well as the management of their environmental, social and governance (ESG) risks. These disclosure requirements stimulate sustainable equities by boosting transparency and confidence in the responsible investing market.

One of the most ambitious pieces of regulation is the European Green Deal, approved in 2020, whose overarching goal is to make the EU climate neutral by 2050. It covers a broad range of areas and comes with at least EUR 1 trillion in financing over the next decade, ensuring that it will make a huge contribution towards achieving emissions targets and sustainable development goals.

Europe is at the forefront with other countries lagging behind. In the US, for example, President Joe Biden’s plans for a massive cash infusion into technologies for fighting climate change have run into opposition. His “Build Back Better Act” has stalled in the Senate and the future of the legislation is uncertain.

Investing for the long term

As investment gained momentum, financial performance followed, with sustainable equity strategies generally outpacing the broader market.[2] This trend has stalled in the first half of 2022, however, under pressure from accelerating inflation, rising interest rates and the geopolitical situation in Europe.

Jeremy Kent, Senior Portfolio Manager Sustainable Equity at NN Investment Partners shares: “Market dynamics this year have meant that many stocks that sustainable equity investors tend to avoid are rising in value. Oil and gas producers have benefitted from the spike in energy prices while defence companies are profiting as western countries rush to arm Ukraine. At the same time, increasing rates will make borrowing more expensive for the growth-oriented companies often found in sustainable equity portfolios. These short-term headwinds could test investors’ resolve.”

Kent continues: “However, despite the current market turmoil, the investment case for sustainable equity strategies remains solid. Factoring ESG criteria into investment decisions is not only seen as an important way to safeguard returns but also to future-proofing portfolios. Sustainability is a source of alpha over the long term because it sets companies up for success in the transition to a greener, more inclusive economy.”

This is the direction the economy and the market are moving, and where the opportunities will be. Disciplined investors will be the ones who benefit from the rewards.

[1] Morningstar, “Global Sustainable Fund Flows: Q1 2022 in Review.” The data encompass open-end funds and ETFs that claim in prospectuses or other regulatory filings to focus on sustainability, impact or ESG factors.

[2] Morningstar, “Do Sustainable Funds Beat Their Rivals?” The report notes that over the 10-year period through 2019, 58.8% of surviving sustainable funds across even categories analysed in a Morningstar study beat their average surviving traditional peer.

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