The rise in ESG investing – a $30 Trillion market story

Published On November 11, 2020
In ESG, Blog Archives

The integration of investment process and critical decision making with ESG (environmental, social and governance) factors is widely understood as responsible investing. With ‘sustainability crisis’ on the rise due to the Coronavirus pandemic, investors and decision makers are pulling up their socks to prioritize sustainable approach to investment. In order to ensure that a company is ESG and sustainability friendly, they must consider all stakeholders. 

In 2018, companies that took their ESG factors into consideration grew more than $30 trillion (Global Sustainable Investment Alliance). This number is gradually shooting up with the fluctuations in investors’ demand and shift in consumer preferences. Companies that incorporate strong ESG practices enjoy the benefits of high reputation and low risk probability because sustainability is ingrained at the core. On the other hand, companies who have low ESG scores, expose themselves and their investors to high risks and sudden losses/shocks in the long-term. 

What is ESG investing? 

ESG investing is a type of investing also known as sustainable investing. It is an umbrella term which is used to define investments that provide positive ROI and long-term impact on environment, society and business performance. According to Financial Times Lexicon, ESG is a generic term that is used in the capital markets and by investors to assess the behaviour of a company and determine their future financial performance. Additionally, ESG includes ethical, sustainable and corporate governance issues such as ensuring that right systems are in place that guarantee accountability or managing an organization’s carbon footprint etc. These issues are important factors while considering investment. 

Why is ESG investing so appealing? 

Several investors aren’t just interested in an investment’s financial outcomes but also its impact, where they are curious to understand the role their assets play in promoting global issues such as climate change. One section of the population that is highly attracted to ESG investing are the millennials. According to Cone Millennial Cause Study, millennials are more likely to purchase a product from a company and trust them on the basis of their social and environmental reputation. Most of the millennials turn down products from companies that are perceived environmentally and socially irresponsible. 

Overview of global ESG market 

ESG investing has witnessed some remarkable momentum in recent years. Being a niche space for many years, ESG investing is now growing at a steady pace in every geography. According to JP Morgan, the assets that follow ESG principles will soon represent 44% of global assets under management (AUM). The “broadly defined” ESG market is expected to reach $45 trillion in AUM in 2020 (JP Morgan). Active ownership practices, products and investment processes are integrating ESG principles at an incremental pace. The size of dedicated ESG funds is significantly low at around $1 trillion, which is nearly 2% share of the market. Interestingly, in 2018, 90% of the market was accounted from North America and Europe.  

Although Europe was the undefeated leader in sustainable finance since a long time, currently the dominant position is enjoyed by North America. BlackRock Chairman and CEO Larry Fink said, “Nowadays higher ESG demand is being seen worldwide, additionally in the United States the largest net changes in demand can be witnessed”. The trend of ESG investing has always lagged in Asia but the movement is extending gradually to this region as well.  

The rise of responsible investing – influenced by younger generations 

With the right motivation and financial aid, now it’s up to the millennials to build a better world. They are indeed a pivotal point. Their strong belief regarding the investments they make in any company depends upon whether the company is going beyond their money-making mindset to actually becoming part of the solution. A study conducted by deVere Group reveals that 77% of the millennial investors believe that ESG issues tops their lists of priorities while assessing investment opportunities.  

The growing influence of millennials is undeniable, because one-third of the population is accounted for by people in the age bracket of 23-38 (as of 2019) (Bloomberg). Additionally, we are in the midst of a gigantic multi-trillion-dollar intergenerational wealth transfer, where resources are being passed on to upcoming generations by baby boomers. This surge in millennial activism has made ESG or sustainable investing a significant trend in the recent years.  

These days, millennials prefer to invest in companies that are in sync with their values, keeping in mind the long-term performance and portfolio diversification as one the key factors while deciding to invest. Moreover, the millennials expect that their investment managers grill the potential investees and work actively to improve their performance and behaviour. This clearly indicates that in the future, investment firms and organizations will need to re-formulate their strategies so as to consider the priorities of millennial investors.  

ESG investing outperforms 

During the stock market decline in late-2018, ESG funds established themselves more resiliently than most other funds. Then, the pandemic took us all by surprise which resulted in the creation of the most volatile market conditions in the stock market history. Even during such market conditions, ESG funds have proven to have outdone themselves. According to a research by Morningstar, while assessing the long-term performance  of Europe-based ESG funds (sample of 745), it was found that majority of the strategies performed better than non-ESG funds over 1, 3, 5 and 10 years.  

The Covid-19 crisis has made it evidently clear that investments that incorporate ESG criteria prove to be more resilient to market turmoil. According to Gabriel Wilson-Otto, head of stewardship, Asia Pacific at BNP Paribas Asset Management, amidst the virus outbreak, investors have been “doubling down” on sustainability funds – where these funds have outperformed the broader market. As compared to other funds, ESG portfolios or sustainable funds have exhibited sharp outperformance across indexes like S&P 500 and MSCI equity index.   

The resilience shown by the ESG funds has not just ensured inflows during these challenging times but, also shown strong performance. Integrating ESG factors can provide a wider view of risk and opportunity, in turn leading to better insights, better risk-adjusted returns and investment decisions. 

ESG stocks are better for long-term investors 

No longer a niche, investing in companies that incorporate environmental, social and governance best practices is one of the effective ways to ensure long-term sustainable returns. With the shift in the global zeitgeist, more and more people across the world are embracing the tenet that betterment of planet is betterment of people. This has highlighted ESG and sustainability as the new imperative for great business and economic growth.  

For long-term investors it is crucial to determine the viability of returns by analysing the company’s ESG behaviours. Here are top three ESG examples in high-quality industries that every long-term investor should consider: 

  1. Software and IT services: Data privacy and security issues are critical. Companies that refrain from monetizing through sensitive customer data have greater long-term interest. This interest can increase if they strive to strike a balance between their own interests and the impact their big data analytics has on society. Companies that promote responsible initiatives and values, which actually make a difference, enjoy the benefits of an engaged workforce. This is highly valuable in the long-run. Few examples of these efforts are – inclusion initiatives, using technology for the betterment of environment, integrating people with autism in workforce, protecting endangered species, contributing to education efforts etc.  
  1. Healthcare: Lack of safe drinking or proper nutrition are some of the pressing issues in the world. Organizations that have invested in rice-fortification technology (which adds essentials vitamins and minerals to rice), have helped in boosting the nutritional value of rice. Considering the fact that around 1 billion people who get affected by lack of nutrition, reside in countries where the staple food is rice, this initiative has helped resolve the problem. Many companies have also focused on water sanitation by developing innovative products. 
  1. Consumer packed goods: Organizations are tackling the challenges of recycling in an interesting manner – some are switching to environment friendly packaging such as removing label adhesives which improves the usability of bottles in recycling, while others are focusing on investing heavily in infrastructure to increase the recycling rate. 

Conclusion 

With millennials and Gen Z taking over the workforce, there is an exponential growth in ESG investing. ESG investing highlights the implications of not incorporating the principles of sustainability in an organization. ESG or sustainability is not a luxury anymore but a necessity. ESG trends are going to on the forefront. The Coronavirus pandemic has successfully put ESG practices on the forefront. Going forward, companies will be able to assess the effects of the crisis, identify their responses and shortcomings and explore opportunities to enhance ESG practices.  

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SGA Digital Marketing Team
SGA Digital Marketing Team
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