Is the sun setting on ESG investing?

Date: 21 Feb 2024

Citywealth

From our interactions with the private wealth industry, Citywealth has gotten the sense that interest in ESG investing is waning. To try and take true temperature of the industry, we spoke to those directly involved in this area to see just how sustainable ESG investing really is.

Some may think the focus on ESG is just another investment trend or tick-box exercise, but research from Morgan Stanley suggests otherwise. According to their report, published at the end of January 2024, individual investors’ interest in sustainability is on the rise. Not only do more than 70% of individual investors believe strong ESG practices can lead to higher returns, more than half are putting their money where their mouth is by planning to increase allocations to sustainable investments in the next year.

Additionally, competitive financial returns and ESG are not necessarily seen as trade-offs by investors. Morgan Stanley’s Chief Sustainability Officer and CEO of the Institute for Sustainable Investing Jessica Alsford said: “Nearly 80% of individual investors believe that it is possible to balance market rate financial returns with a focus on sustainability. These investors express a desire for their investments to advance positive environmental and social impact, creating opportunities for finance professionals to meet these needs.”

Perhaps some of the sensed hesitancy around the progression of ESG investing is in the ‘S’ section of it all. The report found that investors say that they don’t know how to invest in social themes, but suggested that “the lower interest in social themes could reflect investor sentiment toward a less developed market for social funds compared with environmental… While social investment opportunities ranked lower, most investors do say they are a priority for their investments to both minimize negative social impact and advance positive social impact.”

This sentiment looks like it is reflected in the desires of clients as well as those directly investing. Stephen Metcalf, Head of Sustainable Investing for RBC Wealth Management in the British Isles and Asia, said: “We continue to see high-levels of aspirational interest in ESG among our clients who want their investments to drive positive change for people and the planet. What is less clear is how this translates into their investments, particularly when a client’s other priorities and needs are accounted for.”

Metcalf continued: “Furthermore, clients often don’t understand the different terminology, or trade-offs involved in different strategies, and it’s our job to educate and support them on the journey. After this process, the vast majority of clients understand the importance of sustainability and want assurance their investments are doing no harm. With a smaller subset wanting to prioritise certain sustainability issues and build their entire portfolio around it. We expect the latter to grow with the adoption of the FCA’s SDR regulations, which will give consumers more confidence around the sustainability characteristics of products.”

Newcore Capital may be a step ahead then, with their investments into UK social infrastructure real estate assets. Citywealth spoke to Hugo Llewelyn, CEO of Newcore Capital Management, who said: “For Newcore Capital, it has been our view since we began the business in 2011, that it was never possible to separate the planks of E, S and G from a long term sustainable investment strategy. Newcore invests in UK social infrastructure real estate assets.  For them to make a sensible economic return for investors, it has always been critical to have regard to their usefulness to society (S) and the capacity of the buildings to function efficiently from an environmental perspective (E) (or be able to be fixed economically to do so). In addition having on-shore UK operations, a strong ethos around tax and limited financial leverage (G) – all these have been the factors that have allowed us to do well and grow as a fund management business through some tricky market events (Brexit, Covid, QE unwinding).”

On the question of whether ESG investing is just another bandwagon to jump on, Llewelyn said: “Some managers, for whom ESG was never central to their approach, are now disregarding whatever ESG policies they had latterly added in to pure play financial strategies, in the face of post-2022 legacy issues of rising debt cost and reducing valuations. However, investors, in our experience, continue to want genuinely sustainable strategies and managers who adhere to them for the long-term. Those that disregard such principles are likely to struggle to raise capital and deliver sustainable investor solutions when they do.”

He also added: “Investors are undoubtedly wise to, bored of and irritated by greenwashing.” This is also reflected in the Morgan Stanley report, as over 60% of investors reported their concerns regarding greenwashing risks and the lack of transparency with ESG data.

Mike Topley, Head of Sustainable Portfolio Management at Barclays Private Bank, considered the question through an international lens. He said: “We are finding that demand for sustainable investment varies across geography and client type. Within Europe and the UK, demand is strong and sustainable options are now the default for client segments such as charities, corporates, next gens and a growing number of family offices. We have also seen growing demand from our clients across the Middle East, while demand in Asia is more muted. More broadly, certainly some of the excitement for sustainable investments seen over the pandemic years has eased, however we are now seeing more of a stable growth rate that we expect to continue in the years to come.”

From the perspective of clients, Topley said: “There are several reasons our clients are investing into sustainable investment products. Many of our institutional clients – such as universities or sovereigns – do so in order to align their investments with their stakeholder values. Many of our private clients are also switching to sustainable options for example as a way to engage next gens with investing, who are often very much interested in the impact their investments are having on the world. However, I think all clients recognise the power that the allocation of capital can have on addressing our global challenges.”

Citywealth also asked Topley about what trends are currently coming to the fore in the ESG investment space. What issues can we anticipate in the near future? Topley started by clarifying: “We always try to differentiate between ESG and sustainable investing. ESG is about using more information to better understand the operational quality of a business and its ability to mitigate risk, in the pursuit of better investment returns. All of our discretionary strategies incorporate ESG, and I believe this could become the norm across the industry as the years progress. Sustainable investing on the other hand goes beyond ESG to also look at whether the economic activity of an investment is helping to address a sustainability challenge. This area of investing is much more values based.”

On trends, he said: “Within the ESG space, I believe the incorporation of physical risk into due diligence will be a significant area of focus in the years to come. We live in a world being increasingly impacted by climate change, which will affect everything from supply chains, to working conditions, to the availability of labour. For instance, the Panama Canal is currently experiencing a serious drought that has lower water levels to the point that its ship capacity has had to be reduced. At the same time, the IPCC has stated that under current warming trajectory, by the end of the century life-threatening heat and humidity is expected to impact between 50-75% of the global population, with 197 cities having more than 150 days per year with temperatures reaching above 35°C. This is clearly going to have a significant impact on certain industries, and particularly for the 1 billion people working in agriculture or the 430 million people working in the textiles industry. The challenge for investors will be around building an accurate picture of a company’s global assets to understand these risks.”

So the experts have said it: ESG investing is here to stay. The ‘E’ element has been the focus thus far, so progress in this area will see growing understanding of the ‘S’ and ‘G’ sectors and what they have to offer on the balance of investment returns and positive impacts.