Sustainability investing faced considerable headwinds during the last two years, but public perception and actual lived reality diverge wildly when it comes to the subject of ESG. In the wake of having gone through an arguably much-needed identity crisis, the sustainability megatrend remains just as intact as ever today. The importance of sustainability to investors and business leaders is edging further upward in 2024. All that is needed is to search for a replacement for the three letters E, S and G.

Sustainability sentiment in the cellar
The sustainability finance industry was exposed to a harsh climate over the last two years. In 2022, we even found ourselves having to diagnose an identity crisis. The echoes of that identity crisis haven’t faded away yet, particularly in the US, where green financial assets are politically under fire – a situation that will tend to intensify further in 2024 due to the stark polarisation in the US and in the midst of the US election campaign that is heating up.

Although the anti-ESG media drumfire has probably already diminished lately, sustainability sentiment is still in the cellar. But there are actually no grounds for this, at least not with regard to the return performance of sustainable investment strategies. Thanks to their disproportionately high weighting of technology stocks, they outperformed in 2023, making up for their relative weakness in 2022. Strict sustainability investors, however, will view that at most as a nice side effect because in their eyes, the primary objective of sustainability strategies is not necessarily to outperform the broad market, but to earn more or less the same return as before but with less risk.

Whether a devout ESG disciple or merely an investor with a preference for sustainability, investing sustainably is still well liked. It has proved to be much more popular on this side of the Atlantic than it is in the US. This is reflected not least in net flows in and out of sustainable investment funds. While Europe has continued to register constant net inflows in recent quarters, the capital flow in the US already changed direction back in 2022, and the momentum there is still negative. Whereas 55 mutual funds with an ESG focus were launched in the first half of 2023, only eight were rolled out in the second half of last year. At the same time, the universe of sustainable investment funds in the US has actually shrunk in the meantime because more than two dozen funds closed down during the last two quarters. And the political headwinds continue to blow. In January, Republicans in New Hampshire even introduced a bill that would make investing state funds in line with ESG criteria a felony punishable by up to 20 years’ imprisonment. By the end of last year, a total of 18 US states had enacted some form of anti-ESG legislation. Some of the laws prohibit the ‘discrimination’ of companies that sell fossil fuels and firearms while others instruct state pension funds not to take ecological and social factors into account in their investments.

Perception and reality
However, the reality of politics in the US also includes the following observations. Comparable anti-ESG bills were proposed in 19 states but were not adopted, and four states enacted pro-ESG legislation. Furthermore, a Bloomberg Intelligence survey of 250 institutional investors and 250 top-level corporate executives also reveals that public perceptions regarding the sustainability of the sustainability trend are worse than the actual lived reality. Asked if the US political pressure on sustainability investing is prompting them to change their investment strategy, more than half of the investors surveyed (54 percent) said they were now focusing even more on ESG aspects than before. Roughly one in three (31 percent) said they were not going to change their approach. Asked additionally about their spending plans for the next two years, the majority of both groups of respondents said they would increase their sustainability budgets, but what’s more, 38 percent of institutional investors and 23 percent of businesses even want to expand their sustainability budgets by over 20 percent. The clear conclusion of the study is that sustainability investing is not going away anymore.

The vast majority of investors and fund managers implicitly or explicitly factor climate and social risk factors into their decisions these days. However, not all of them want to utter the letters E, S, G anymore, including BlackRock CEO Larry Fink, who once rode atop the ESG wave a few years ago. He now asserts that “the term ESG has been weaponised,” but his avoidance of using that expression has not changed his attitude about the sustainability issue. In fact, BlackRock’s latest bet – its acquisition of infrastructure specialist Global Infrastructure Partners – fits excellently with this megatrend because a substantial part of worldwide investments in infrastructure over the next decade will likely be funneled into projects for sustainable energy production, decarbonisation, and the necessary grid infrastructure.

Sustainability research has an impact
If investors today are already intensely interested in sustainability issues and will become even more so in the future, that is a good thing for our planet because they appear to be indirectly prodding businesses to reduce their greenhouse gas emissions. This theory is corroborated by a study that was conducted by researchers at the University of Leeds and Durham University. They investigated what happens when research departments of brokerages close or merge and the number of analysts covering a company decreases as a result. They discovered that as soon as a company is covered by fewer analysts, its greenhouse gas emissions start to increase.

The researchers identified four primary channels as the cause of this correlation:

1) fewer critical environmental questions raised during conference calls,
2) higher costs for institutional investors to monitor a company’s ESG performance,
3) fewer investments by companies in cleaner environmental technologies, and
4) less concentration and managerial leadership on sustainability issues.

Conversely, the study shows that companies have an incentive to operate more sustainably when they are being monitored more closely by analysts. In an era in which the focus on sustainability is intensifying (and budgets for sustainability research are growing), less sustainable companies are likely to increasingly get blacklisted by investors in the future and are bound to come under pressure on the stock market if they continue to rebuff and defy the sustainability megatrend. Viewed objectively, pressure from investors is working much better than headlines in the media would subjectively lead one to believe.