Green believers vs ESG naysayers: is the net zero investment space in rude health?

Who does not love studying statistics? Probably quite a lot of people but for asset owners and capital managers, hard numbers can simply not be ignored.

The past year has brought a number of prominent topics to the fore in sustainable investing – below we look at some of the statistics behind these topics and what they might tell us going forwards.

Firstly, exactly how much is invested in sustainable strategies? 

Data from Morningstar shows that assets in sustainable strategies globally hit $2.5 trillion at the end of 2022. This was slightly down from its peak of around $3 trillion a year before, but with markets selling off materially last year, a decline in absolute terms is unsurprising.

According to Iain Snedden, senior investment specialist equities at Aegon Asset Management, "perhaps more informative is the trend in net flows, such as removing the effect of market movements and looking solely at how much people are contributing, or taking away, from funds in the space."

London-based Snedden told Net Zero Investor: "Happily, the picture is more favourable here, with net flows remaining positive throughout 2022 and picking up in the final quarter." 

"Given the difficult market backdrop, this underlines the enduring demand for sustainable funds and is in stark contrast to the broader market, which saw $200 billion of net outflows in quarter four."

Regional bias and investor preferences

What is really striking about the Morningstar numbers is the regional bias. Sustainable investing remains very much centred in Europe, which boasts an 83% share of assets. 

Despite being the world’s largest market, the US lags far behind with an 11% share, and Asia Pacific ex-Japan has just 2%.

Snedden pointed out that "despite these regions being home to many fantastic sustainable companies and a good proportion of the stocks held across sustainable portfolios, they remain massively under-penetrated in terms of actual client allocations, which seems a strange paradox."

"In time, one would expect the numbers to increase, and data on investor preferences seems to back this."

For example, a survey by PwC found that 8 out of 10 US investors planned to increase their allocations to ESG strategies over the next two years.

Furthermore, the same research found that 39% of the institutional investors surveyed had decided not to invest with an asset manager or had stopped investing with one due to perceived shortcomings in their ESG products.

A further 50% said they would consider taking such action, although they hadn’t done so yet. Clearly, managers are rightly being held to high standards when it comes to their ESG offerings.

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Performance

Performance will clearly play a significant role in helping or hindering the future trajectory.

On this front, the past year has been tough for sustainable funds, although they have been far from the only group to suffer. Data from RBC shows that the median globally focused sustainable equity fund underperformed its traditional equity counterpart by 2.4 percentage points in 2022.

"Disappointing, for sure, but this was after a three-year run of sustainable funds outperforming, which means that the sustainable category outperformed by 0.5 and 0.7 percentage points over three and five years respectively," Snedden noted.

The top performing sector in the MSCI ACWI (and the only one to post a gain in absolute dollar terms) was Energy, which returned 34.5%. This was 38.4 percentage points ahead of the next best performer, which was Utilities.

In general, the sectors that performed best last year are "not typical hunting grounds" for sustainable investors, as Snedden put it.

Once this effect is accounted for by looking on a sector-neutral basis, data by RBC shows that stocks with low ESG risk ratings on Sustainalytics underperformed those with high ratings by a much smaller margin.

Regulation

Finally, regulation is a hot topic, with the EU’s SFDR in particular grabbing the headlines.

Several managers found that they had been overly optimistic in categorising funds as ‘Article 9’ (having a sustainable investment objective) and had to row back on this when the regulations became clearer.

An incredible 307 funds, with combined assets of €170.1 billion, were downgraded from Article 9 in Q4 alone.

"In an industry continuing to combat greenwashing, this has been an unhelpful story," Snedden said.

"Overall, these above statistics show that sustainable investing remains in good health, despite the performance and regulatory challenges of the past year," he stressed.

Nevertheless, Snedden pointed out that "the coming months will likely see continued debate around the ‘anti-ESG backlash’ in the US, particularly given moves by some states to disinvest from asset managers which they believe are prioritising ESG issues over investing in the polluting industries at the heart of their economies."

He stressed that "hopefully this doesn’t derail the positive momentum that sustainable investors have worked so hard to build."

And with the Biden administration passing the Inflation Reduction Act and making it easier for retirement plan sponsors to include ESG funds among employee investment options, "these should act as important counterweights to some of the short-sighted actions seen at state level," Snedden concluded.

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