ESG investing – the new normal?

Investing in line with your values and making money could seem too good to be true.

For a long time, many investors saw Environmental, Social and Governance (ESG) as a “nice to have”, rather than a serious investment strategy. Some of those claims have been silenced during the recent volatile drops. While markets fell across the globe, ethical investing came out just about on top against the main equity indices.

The question now is not whether ESG investing is here to stay, but whether it will become the new normal.

This article isn’t personal advice. If you’re not sure if an investment is right for you, please speak to a financial adviser. Past performance isn’t an indication of future performance.

Outperforming mainstream equity indices

The debate surrounding ESG investing has gone on for some time now.

Supporters have long advocated that it produces similar or superior results compared to mainstream equity indices. But not everyone’s convinced.

The most common complaints were that ESG funds suffer from a lack of diversification, clarity and experience. Many suggested ESG was the new kid on the block, yet to be tested.

But over recent difficult weeks, ESG investing has come out swinging.

So far in 2020 (to the end of March), 60% of European ESG ETFs (Exchange Traded Funds) have outperformed broader European markets. It’s a similar story in the US, with 59% of ESG ETFs outperforming the US market.

This has raised eyebrows, along with hopes that investors will now see the impressive potential of ESG investing.

Please also remember that all investments can fall as well as rise in value, so you could get back less than you invest.

More about ESG investing

ESG outperforming isn’t just down to oil prices

The global market falls were partly due to an oil price war between Russia and Saudia Arabia. Many large-cap indices and tracker funds contain significant amounts in oil companies. As oil prices crashed, so did the values of those companies and that contributed to indices’ poor performance.

But surprisingly, many ESG indices hold oil companies too.

For example, the FTSE4Good Developed Index includes Royal Dutch Shell. And the MSCI ACWI ESG Universal Index includes BP – despite claims BP was among the highest spenders for anti-climate lobbying last year.

Some companies you wouldn’t expect are in ESG funds. Some make the grade because of their corporate structure and focus on social impact – irrespective of what industry they’re in. For example, by having more women in senior positions, or making efforts to reduce carbon emissions.

A key question for investors might be – can addressing ESG issues benefit a company’s share price?

The evidence certainly seems to point in this direction, with the majority of studies showing a positive relationship between ESG and corporate financial performance. For investors looking to capitalise on this space and strike while the iron is hot, it could be worthwhile looking at an ESG investment.

ESG investing to become the new mainstream

Last year, Google, Facebook and Amazon were found to be the world’s biggest buyers of renewable energy in order to help power their data centres. As leaders in the tech space, this will surely help lead the way. And change seems to be happening across other industries too.

Earlier this year, Larry Fink, the CEO of investment powerhouse BlackRock made a similarly bold statement to his fellow chief executives, saying “climate risk is an investment risk”. This was in the hope that they’ll make sustainability an integral part of their portfolio construction and risk management.

The demand for ESG investing is growing fast. And its popularity is likely to increase further as ESG’s greatest supporters, Millennials, come into money and we see what’s known as “The Great Wealth Transfer”.

Around £5 trillion is expected to pass from Baby Boomers to their children over the next few years. Research shows 90% of Millennials want to invest according to their ESG values, with 84% of Millennial investors already doing so.

The Bank of America Corporation estimates that ESG funds will rival the S&P 500 within the next twenty years, anticipating growth to $20 trillion of assets.

It’s fair to say, ESG investing is here to stay.

Hannah Duncan is an investment writer, and founder of Hannah Duncan Investment Content, with years of experience producing content for global leaders in finance and retail.