Future Returns: Sustainable Investing Poised To Gain Assets

Assets in sustainable strategies are rising at a fast clip globally, with US$35.3 trillion invested as of 2020, according to a report out this week from the Global Sustainable Investment Alliance or GSIA, an international collaboration of membership-based sustainable investment organisations.

With several changes afoot in regions across the world, these figures are likely to climb further by the time the next report is released in two years. In the U.S.—where 48% of sustainable investing assets resided as of the beginning of 2020, according to the report—potential regulatory and legislative changes are expected to spur further interest in sustainable strategies.

The report, titled the Global Sustainable Investment Review (GSIR), is based on data provided through Dec. 31, 2019, with the exception of Japan, where the data is collected through March 31, 2020.

In part, that’s because these changes will lead to a rise in investments by individual investors in sustainable investing—which include a range of strategies emphasizing environmental, social, and governance, or ESG, matters. Currently about 25% of all investments in sustainable strategies are by “non-institutional” investors, a figure that held steady between the last two reports.

One reason assets haven’t expanded as fast in the retail market is that growth typically comes from retirement funds, where a majority of retail assets are invested, says Lisa Woll, CEO of US SIF: The Forum for Sustainable and Responsible Investment, a membership organization focused on shifting investment practices to sustainability.

And, Woll points out, the U.S.’s largest retirement plan—the US$760 billion Federal Thrift Savings Plan—doesn’t offer any ESG options to its 6.2 million members, Woll says.

Beginning next summer, however, members will be offered the option of investing in ESG mutual funds in response to a May executive order on climate-related financial risk from President Joe Biden.

Among several items, the order asks the secretary of labour to assess “how the Federal Retirement Thrift Investment Board has taken environmental, social, and governance factors, including climate-related financial risk, into account.”

“We’ve worked on this for a decade, to get them to implement that,” Woll says.

Penta recently spoke with Woll about trends in sustainable investing globally and in the U.S., much of which was detailed in the group’s own report on sustainable and impact investing trends in November.

Shifts in the U.S. Regulatory Landscape

Another drag on asset growth in retirement funds was the “anti-ESG agenda” of former President Donald Trump’s administration, Woll says. “Now, it’s a new era.”

The U.S. Department of Labor in March stated it would not enforce Trump-imposed rules limiting the ability of retirement-plan administrators to consider ESG factors in retirement options, and to engage in proxy voting on ESG-related issues, according to the report.

Also in March, the Securities and Exchange Commission took initial steps that could result in requirements by corporations to disclose climate-related risks to their operations in addition to a “potentially a broader set of ESG issues,” the report said.

More broadly, the Biden administration is addressing several ESG themes in addition to climate. One example is labour rights, the subject of the new White House Task Force on Worker Organizing and Empowerment.

The potential implications for ESG investing from the array of government actions taken so far, and those to be expected, haven’t fully been analysed yet, and could be significant. The climate-change directive, for instance, “affects so many different agencies in different ways,” Woll says.

And, she notes, a more recent executive order on competitiveness includes language about treating employees better, which is a key governance concern for investors.

It’s about “creating better capitalism and better companies,” Woll says. “There are all kinds of interesting focal points, including diversity, equity, and inclusions—big policy priorities for the administration and our members.”

The Rise of ESG Integration

By far the most popular sustainable investing strategy—representing US$25.2 trillion in assets globally—is “ESG integration,” an approach where ESG factors are explicitly included in financial analysis, according to the GSIA.

That’s a major switch from 2018, when negative screening was the most popular global strategy with nearly US$20 trillion in assets compared to US$15 trillion by 2020. Negative or exclusionary screening—which remains highly popular in Europe—removes categories of investments such as companies engaged in making weapons or tobacco, or those involved in human rights abuses, versus seeking out companies engaged in best ESG practices.

One reason for the popularity of this approach is that any investment manager who wants to get business increasingly needs to be a signatory to the Principles of Responsible Investment (PRI), a U.N.-sponsored network of investors, Woll says. “ESG integration was very much the preferred strategy taken up by those signatories.”

In the U.S. Woll is concerned, however, that many companies offering ESG integration strategies don’t clearly articulate their criteria, making it difficult for investors to know what kind of impact their investments are having.

“We have to have more transparency around this,” she says.

The Global Picture

While the GSIR report provides a good snapshot of sustainable investment trends in five major markets (the U.S., Canada, Japan, Europe, and Australia/New Zealand), it also reveals a sector that’s in flux as changing frameworks, regulations, and definitions make it difficult to precisely track global trends.

For instance, in Europe, assets invested in sustainable strategies fell 13% to US$12 trillion from US$14 trillion in 2018. But that decline simply reflects changes in regulatory definitions that no longer include some products or strategies.

In Australia and New Zealand, assets grew to US$906 billion from US$734 billion, but the growth was at a slower pace because of new industry standards for sustainable investment.

Given different strategies and different regulatory environments, the countries from major markets involved in the report are recognizing that field-builder institutions such as US SIF or the European Sustainable Investment Forum need to be resources for best practices, Woll says.

A 291-point or 3.69 percent dive in the benchmark ASX 200 index over April has all but wiped out the Australian share market’s gains for 2024. There was a 140-point or 1.81 percent drop in the ASX 200 on Monday and a minor further fall yesterday. The Australian market has followed the US lead this month, with the S&P 500 also down significantly, losing 232 points or 4.42 percent since 1 April.

The catalysts include last week’s hotter-than-expected US inflation data. Although analysts think Australian inflation is unlikely to follow suit, stickier-than-expected inflation in the US may delay the first interest rate cut by the US Federal Reserve. As the US is the world’s largest economy, this may have implications for central bank decisions in other nations like Australia.

“ … uncertainty over when the Fed will start to cut rates has been increased by three worse than expected monthly CPI inflation results in a row …,” said AMP chief economist Dr Shane Oliver. “This has seen money market expectations for 0.25 percent rate cuts this year scaled back from seven starting in March this year to now less than two starting in September. And in Australia they have been scaled back from nearly three starting in June to no rate cut until late this year/early next.”

On top of that, Iran’s retaliatory strike on Israel and Israel’s insistence that a response will be forthcoming despite many Western nations’ objections have made investors nervous. If Iran were to become more involved in the ongoing war, this may have ramifications for oil prices.

“Another sharp spike in oil prices would be a threat to the economic outlook as it could boost inflation again … potentially resulting in higher than otherwise interest rates and act as a tax hike on consumers leaving less to spend on other things,” Dr Oliver said.

Also, in Australia, the pandemic savings buffers people have been using to cope with the cost of living crisis are being depleted and China’s weak property sector is impacting demand for iron ore. All of this makes shares vulnerable to a pullback amid stretched valuations and more trading volatility ahead, Dr Oliver said.

On balance though, Dr Oliver thinks an upward trend is likely to remain for shares. “From their lows last October, it has been relatively smooth sailing for shares – with US shares up 28 percent, global shares up 25 percent and Australian shares up 17 percent to recent highs.”Dr Oliver said the past few weeks have “seen a rough patch” but the share market is likely to continue its bull run.

Markets have been strong since November 2023 due to falling inflation and optimism that the interest rate cycle is at its peak. Many economists have expressed surprise that the jobs market in many Western countries has remained strong despite weaker economic conditions. Some are terming this “immaculate disinflation” because it goes against the traditional trend of many people losing jobs when economies slow down.

Dr Oliver says there are five reasons to be optimistic about the share market’s strength:

1. Technical market indicators, including churning and a decline in the proportion of stocks reaching new price highs – common at the top of markets – are not in play

2. Global and Australian economic conditions and company profits are holding up better than expected

3. Inflation has fallen sharply in many major economies, so while rate cuts may be delayed, they are still likely

4. China still expects about 5 percent economic growth this year despite its property slump. The iron ore price has fallen but remains in the same range of the past two–and–a–half years

5. Geopolitical risks remain high but an escalation may not eventuate, just like last year.

In this climate, Dr Oliver recommends that investors stick to an appropriate long-term investment strategy and accept that share market pullbacks are “healthy and normal”.

Future Returns: Sustainable Investing Poised To Gain Assets

The Global Sustainable Investment Review indicates assets are rising quicky.

But leading Australian economist says there are five reasons for investors to be optimistic about the future

Dr Oliver says there are five reasons to be optimistic about the share market’s strength: