Written by: Wilbert Fung, Andrei Sosnin
Introduction:
Environmental, Social and Governance have become staple criteria for investing. Considering the sustainability of an investment is only becoming more prominent when choosing to invest in a project. With growing traction, it was only imminent that funds citing ESG as their attributes will start emerging. This was the case for a long time. Between 2020 and 2022, the value of sustainable investments grew by 15%, as stated by the Global Sustainable Investment Alliance. However, a very different image became apparent as of late 2023. This article explores the sudden decrease in ESG fund launches in the second half of 2023, its causes and implications for the future.
Brief Overview:
To start with, it is crucial to understand the basics of both ESG and funds separately. ESG refers to Environmental, Social and Governance - key aspects of disclosures that companies are required to file under the new European legislations in sustainable finance. ESG aims to depict all non-financial opportunities and risk concerning the company in question. When it comes to each of the pillars separately:
Environmental - this refers to the emissions, like greenhouse gases, pollution, including noise and water pollution, the usage of recycled or virgin resources and the commitments to a circular economy.
Social - this reports on the company's relations with their labour and other people. Worker developments and treatment, dangers associated with the product and other health and safety notices are all covered under the S.
Governance - the G refers to the rights of shareholders, diversity in its board of directors and how the management compensations correlate with sustainable performances of the enterprise.
When it comes to ESG funds, this means investment portfolios which take account of the above factors when deciding on investments. To break this down, when deciding on an investment, tests and research are carried out, which flow into an ESG score - a quantifier of sustainability. The funds then pool in investment from many different investors into the created collection of assets. ESG Funds specifically are very important in risk management. Good sustainable performance is seen to decrease long-term risks due to the perceived longevity of firms. Knowing that the company cares for its future means it is likely to cope better when finite resources eventually start running out. Growing strictness of environmental regulations also "future-proofs" the investment. The diversified portfolios of "green" stocks also align well with the values of some investors.
A Look Into the Past:
Before approaching the current trends it is extremely important to look back at ESG funds' past performances. Their share of assets under management (AUM) has steadily increased over the years, largely due to technological advancements in the field and the rising awareness and integration of ESG into households' daily lives.
Analysis of the Decrease:
There was a significant reduction in the amount of ESG fund launches recently (2023). In 2022, there was a total of 993 ESG fund launches, which decreased to 556 in 2023. ESG funds citing environmental, social and governance factors especially, had only 6 launched funds in the last 2 quarters of 2023.
The likely main reason behind this, according to researches, was due to investors focusing more on performance-based statistics instead of considering more about future impacts when evaluating these funds. In addition, ESG funds has had bad performances, for example BlackRock’s iShares ESG Aware MSCI USA ETF has lost more than $9 billion in assets, which may have contributed to the loss of confidence of investors in such funds.
Industry Perspectives:
Not all economic sectors perceives different ESG issues the same way. In other words, different industries may see the same ESG issue having a different importance, which is so called materiality. For example, with banks, energy is more important than greenhouse gas emissions.
Companies may need to report ESG. Although there is not a standard method to do this, a couple of frequently used frameworks do exist, such as the Global reporting initiative (GRI) and the Sustainable Accounting Standards Board’s standards (SASB). GRI tend to focus more on the effect of development on the three pillars mentioned above, whilst SASB focus on how sustainability issues affect the decision of investors. One of the negatives of having no standard framework is that companies may decide to show only favourable information and hide ones that may cause investors to hold back on investing.
Implications for the future:
Currently, as mentioned above, there are a few reasons preventing ESG funds to grow at a high rate, including skepticism from investors and macro challenges like the US election (2024) which brings uncertainty. However, ESG funds are still expected to grow over the decade as increased regulations and enhanced scrutiny can increase its credibility to a certain degree, causing it to mature and grow. The leading region of ESG funds now is Europe, which is also predicted to be keeping its position to at least 2030, where it is estimated to have over $40 trillion in assets. Japan, Canada and Australia are now considered as fast-growing regions, which may support and contribute to the growth of the ESG market if they continue to expand.
Conclusion:
In conclusion, ESG funds may have some drops in investments in the short term due to temporary challenges, but in the long term, the market is still anticipated to grow. In the future, it is possible that the awareness of the importance of sustainable development increases as well as standardised reporting frameworks being developed. In addition, it is likely that more investors will discover the benefit of ESG being able to reduce long term risks, which may further expand the investments to it.
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