The rise of ESG investing: a game changer for financial markets

Published on January 19, 2024 by Paritosh Singha

Environmental, social and governance (ESG) investing, also known as sustainable investing, is rapidly transforming financial markets. By integrating ESG factors into investment decisions, ESG investors are seeking to create a more sustainable future while generating superior financial returns.

Growth factors for ESG investing:

Investor demand: Investors are increasingly aware of the risks associated with climate change and other ESG challenges and are demanding that companies take action to address these risks.

Performance: Studies have shown that companies with strong ESG performance tend to outperform their peers on a number of financial metrics, including return on equity, total shareholder returns and risk-adjusted returns.

Policy support: Governments around the world are increasingly supporting ESG investing through policies such as tax breaks and mandatory disclosure requirements.

The impact of ESG investing on financial markets is already being felt. ESG funds are outperforming traditional funds in many asset classes, and companies are increasingly responding to investor demand by improving their ESG performance.

For example, a recent study by Morningstar found that global sustainable equity funds outperformed traditional equity funds by an average of 2.1% per year over the past five years. Additionally, a survey by BlackRock found that 85% of investors believe that ESG factors are important to their investment decisions.

Impact of ESG investing:

ESG funds are driving investment in clean energy and other sustainable technologies. For example, a recent report by the Global Sustainable Investment Alliance found that global sustainable investment assets in clean energy reached a record USD8.7tn in 2022.

ESG investing is helping to reduce corporate greenhouse gas emissions. For example, a recent report by the Carbon Disclosure Project found that the number of companies setting science-based targets for reducing greenhouse gas emissions increased to over 2,500 in 2022 from 200 in 2015.

ESG investing is improving corporate diversity and inclusion. For example, a recent report by the World Economic Forum found that the number of companies with gender diversity targets increased to 50% in 2022 from 10% in 2015. 

Engaging in ESG investing:

ESG investing encompasses strategies and approaches that consider ESG factors when making investment decisions. The following are some of the common types of ESG investing:

Negative screening: This approach involves excluding companies or sectors that engage in activities or practices considered harmful to the environment, society or ethical principles. For example, an ESG investor would exclude tobacco companies such as Philip Morris International and firearms manufacturers such as Smith & Wesson Brands from their portfolio.

Positive screening: This focuses on identifying and investing in companies that exhibit strong ESG practices or are actively engaged in sustainability initiatives. Investors seek out businesses with a positive impact on the environment or society. For example, an ESG investor would actively invest in clean-energy companies such as Tesla, which produces electric vehicles and sustainable energy solutions.

ESG index investing: This focuses on tracking indices that specifically include companies with strong ESG practices. Investors can choose from ESG indices that screen and select companies based on ESG criteria. For example, an investor could allocate funds to the Vanguard ESG U.S. Stock ETF, which tracks the FTSE US All Cap Choice Index, focusing on US companies with strong ESG performance.

ESG exchange-traded funds (ETFs): These are investment funds that track ESG-focused indices or portfolios of companies. They allow investors to gain exposure to a diversified set of ESG-compliant assets with the convenience and liquidity of ETFs. For example, an investor could choose the iShares MSCI ACWI ESG Universal ETF, which tracks an ESG-focused index and provides diversified exposure to companies with strong ESG practices.

Green bonds: These are fixed-income investments specifically designed to fund environmentally friendly projects. Green bonds are often issued by governments, municipalities or corporations to support initiatives such as renewable energy, clean transport or sustainable infrastructure. For example, the State of California is issuing green bonds to finance the construction of a new solar-energy project, enabling investors to support clean-energy initiatives while earning interest.

Impact investing: This involves making investments that generate measurable positive social or environmental impacts, in addition to financial returns. Investors seek out opportunities that align with their values and that are designed to address specific issues, such as affordable housing or clean-energy projects. 

ESG investing by top firms:

• BlackRock, the world's largest asset manager, has committed to making sustainability a core consideration in all of its investment decisions.

• Goldman Sachs has launched a new ESG investment platform that will provide investors with access to a range of ESG-focused funds and investment products.

• Morgan Stanley has committed to investing USD200bn in sustainable finance initiatives over the next five years.

• JPMorgan Chase has committed to investing USD100bn in climate change mitigation and adaptation initiatives over the next decade.

Conclusion:

ESG investing is having a significant positive impact on financial markets, companies and society. For investors, ESG investing offers the potential to generate superior financial returns while supporting more sustainable businesses. For companies, ESG investing can help reduce risk, improve reputation and attract and retain top talent. For society, ESG investing can accelerate the transition to a more sustainable economy.

The rise of ESG investing is a watershed moment for financial markets, ushering in a new era of investing that is more responsible, sustainable and profitable.

How Acuity Knowledge Partners can help

The rise of ESG investing is reshaping the financial landscape, creating opportunities for sustainable growth and responsible business practices. We stand as a strategic partner, guiding companies and investors towards a future where financial success goes hand in hand with ESG responsibility. As ESG investing continues to gain momentum, we remain committed to empowering businesses to thrive in this new era of sustainable finance.

Sources:

• https://www.morningstar.com/views/esg-investing-trends

• https://www.blackrock.com/us/individual/insights/blackrock-investment-institute/outlook

• https://www.morningstar.co.uk/uk/news/203214/do-sustainable-funds-beat-their-rivals.aspx

• https://corpgov.law.harvard.edu/2023/06/29/the-rise-of-international-esg-disclosure-standards/

• https://www.gsi-alliance.org/

• https://en.wikipedia.org/wiki/Carbon_Disclosure_Project

• https://www.weforum.org/publications/global-gender-gap-report-2023/

• https://www.investopedia.com/

• https://www.blackrock.com/corporate/investor-relations/larry-fink-ceo-letter

• https://www.gsam.com/content/gsam/us/en/institutions/strategies/explore-by-solution/esg-

• https://www.morganstanley.com/press-releases/morgan-stanley-announces-commitment-to-mobilize

• https://www.cnbc.com/2021/04/15/jpmorgan-pledges-2point5-trillion-over-10-years-toward-climate-change.html

• https://www.iisd.org/itn/en/2018/10/17/international-investment-law-and-sustainable-development-key-cases-from-the-2010s-stefanie-schacherer-nathalie-bernasconi-osterwalder-martin-dietrich-brauch/

• https://www.ussif.org/

• https://www.gsi-alliance.org/

• https://www.unpri.org/download?ac=10948

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