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Just as the tech sector has done before it, responsible investing continues to mature and grow – and for four solid reasons

The progress of structural growth trends is seldom linear. These days, the march of technology may seem unarguable but that would be to overlook the fact that, along the way, the sector has attracted its fair share of doubters while share prices for tech businesses have been up and down – and a similar phenomenon now appears to be at play with responsible investing.

A recent slide in share prices for companies involved in the transition to greener energy sources has given the naysayers a chance to suggest that sustainable investing’s latest spell in the spotlight will be shortlived. Yet in reality, just as technology has done before it, responsible investing continues to mature and grow, regardless of share prices – and for a number of very solid reasons.

The past 12 months has seen climate change rise up the agenda for governments around the globe and, in particular, the world’s largest powers have been keen to demonstrate their commitment to decarbonisation. The US has rejoined the Paris Climate Accord under president Joe Biden’s administration while China has committed to attaining ‘net zero’ by 2060. Other countries, such as Japan and Korea, have made similar pledges but, without the participation of these two global behemoths, real progress would be near impossible.

Governments have also put their money where their mouth is, backing up their commitments with significant capital. Biden has unveiled a $2trn (£1.46trn) infrastructure package, which includes plans to convert public transport to clean fuel and electricity, incentives for US production of electric cars and the build-out of a charging infrastructure, plus energy-efficient homes and buildings. For its part, the European Union’s €1trn (£850bn) Green Deal is even more ambitious, targeting not just climate change initiatives, but biodiversity, sustainable agriculture and energy efficiency.

From extreme climate events to the Covid-19 pandemic, the past few years have prompted a sea change in the way investors view sustainable investment. It is now firmly mainstream. The recent BNP Paribas Global Survey 2021 indicated, for example, that more than one-fifth (22%) of institutional investors are integrating ESG in at least three-quarters of their portfolios. In the same survey in 2019, not a single investor envisaged this would be the case.

The same survey found almost half (45%) of respondents believed ESG capabilities were embedded throughout the organisation rather than being the preserve of specific teams – almost double the level of the previous year’s survey.

Trevor Allen, sustainability research analyst, global markets at BNP Paribas, says there is still progress to be made, but adoption is accelerating. “There is a barbell,” he continues. “You have a fifth of investors saying it is critical to everything they do, but you still have 44% of investors saying they integrate it into 45% or less of their investment portfolios.

“When we look forward, however, in two years 55% of our respondents expect ESG will be integrated into at least 50% of their portfolios. The trajectory we see for ESG integration is not tapering – it is actually increasing.”

This new investor interest is reflected in fund flows. Morningstar data shows that assets in global sustainable mutual funds pushed on to new highs in the second quarter of 2021 after attracting a further $139bn of flows. While this represented a slowdown from the first three months of the year, clearly demand remains robust.

The sustainable investment sector is broadening in a number of ways. First, investment managers are moving beyond climate change and extending their analysis into areas such as biodiversity, the circular economy, water and sustainable supply chains. In the second quarter of 2020, for example, EdenTree launched a new thematic engagement on biodiversity, analysing the actions that 20 of its investee companies were taking in this area, with the aim of identifying best practice and encouraging better disclosure.

Such areas are more complex to analyse than carbon emissions and coverage is therefore less advanced. Performance metrics are not well-established and corporate disclosure is still in its infancy, but the progress made on climate change disclosure and targets shows progress can be rapid once investors turn their attention to a particular area.

While the majority of ESG strategies are still equity-based – at around two-thirds of the market, both in terms of numbers of funds and assets under management – strides are being made in other asset classes. There has been exponential growth in green bonds, for example, with issuance hitting $228bn in the first six months of the year, including the EU bond programme designed to help the Covid-19 recovery effort. Spain issued its first sovereign green bond in September and the UK is set to launch green gilts by the end of the year.

Sustainability considerations are even starting to make their infuence felt in the commercial property sector. Abrdn’s property team, for example, is integrating ESG across its portfolios, engaging with tenants on installing photovoltaic units and electric vehicle charge points, and working with them to understand their energy consumption and waste policies.

In its latest Good Investment Review, meanwhile, Square Mile Investment Consulting & Research highlights a clear impetus behind environmental infrastructure funds with three new launches.

Developments such as these are making it easier to build diversified portfolios, which in turn has helped investment groups construct new multi-asset funds. M&G, for example, has launched three Sustainable Multi-Asset funds – Balanced, Cautious and Growth – while Abrdn now has its ASI Multi-Asset Climate Solutions Fund.

The European Union’s Sustainable Finance Disclosure Regulation came into effect in March – albeit a watered-down version. Asset managers say an earlier iteration had demanded impossible levels of granularity, asking them to report on specific metrics that were simply not available from the underlying companies. It remains to be seen how regulators and investors will resolve this issue.

Nevertheless, corporate disclosure is improving. Daniele Cat Berro, a director at MainStreet Partners, an ESG advisory and portfolio analytics specialist, says: “We view disclosure as a work in progress – one that depends heavily on the ability to build ESG assessment tools that not only look at companies’ policies, but also promptly integrate newsflow and are supplemented by experts with relevant experience and a track record in the sector.

“There are various public, regulatory and private initiatives trying to tackle the disclosure enigma and these are currently focused largely on environmental aspects. The EU Taxonomy, for example, will require companies to disclose their environmental economic activities related to climate change mitigation and adaptation from 1 January 2023, in line with precise rules and indicators provided.”

The market is heading in the right direction, Cat Berro suggests, although the path to consistency of approach and accurate metrics is still lengthy and challenging. For her part, Yasmine Svan, senior sustainability analyst at Legal & General Investment Management, says the Task Force on Climate-related Financial Disclosures is having a significant impact, but adds: “We encourage companies to ensure data is externally verified. If we cannot test the data, lots of things fall apart.” ■

AND ONE REASON HOLDING IT BACK ... ‘GREENWASHING’

The sustainable investing sector may have made good progress in recent years but ‘greenwashing’ – attempts by businesses to buff up their environmental credentials to a more vibrant shade of green than they merit – remains a concern.

According to Daniele Cat Berro at MainStreet Partners, disclosure is not homogeneous and can still be misleading. “It is often used more as a marketing tool, rather than a genuine risk management one,” he continues. “A clear illustration of this dynamic is the correlation between ESG ratings and the size of companies – larger ones are generally better at communicating and showcasing their efforts in relation to sustainability.”

Nevertheless, sustainable investment teams and rating agencies are wise to the problem. Square Mile, for example, has launched a subsidiary – 3D Investing – that is dedicated to providing independent evidence that funds meet their responsible investment claims, while Yasmine Svan says Legal & General Investment Management scrutinises all ESG claims made by companies. “Corporate ambition has increased significantly, with more companies publicly committing to net-zero targets, but investors still need to check under the hood,” she adds. “Can we see those same ambitions in their capital expenditure or research and development plans?”

There is also increasing evidence of asset managers selling up where engagement fails. Groups such as Royal London Asset Management and EdenTree are becoming bolder, publicly disinvesting if they do not believe engagement is working.

“Our experience tells us that, unless engagement has teeth and carries a real threat of divestment and/or public rebuke, then it is not enough to compel companies to evolve,” says Rize ETF co-founder and director Stuart Forbes. “Of course it is complicated and there is a whole value chain of asset management that is complicit in the status quo – that is to say, not just asset managers. Still, if asset managers are waiting for the perfect solution before voting with their feet, then it will never happen.”