Love it or loathe it, ESG is here to stay

Posted 24 March 2023

ESG has grown in popularity, but current macroeconomic challenges are forcing some to reconsider the merits of its integration.

The ongoing conflict between Russia and Ukraine has been a significant driver in this shift, forcing energy relationships to be redrawn. Cutting Western economies off from Russian oil and gas has created a scrambling for replacements, which has led many markets to alternative fossil fuels. Commodity prices have rallied, causing oil and gas stocks to outperform renewable sources and potentially threatening energy transition projects. While these are challenges, dismissing ESG as a fad is a mistake.

A vulnerable time for ESG

Volatility inspired by the war in Europe has caused many investors to suddenly become risk-averse. The timing is less than optimum for continuing ESG momentum. Regulation in the space is still taking shape. A lack of standardisation of data exists. Investors are even unsure about the exact terminology to use with terms like ‘sustainable’ and ‘impact’ used interchangeably with ESG. This can all create obstacles for new entrants to the market, which may prefer to see the space become more sophisticated and structured before committing capital.

At the same time, inflation has surged in many major economies raising further questions for investors. So, in the search for assets that will protect portfolios and outperform inflation, is the ESG theme strong enough to navigate this challenging period?

Staying the course

In times like this it is all too easy to view ESG through a critical lens, but it is here to stay. Mounting evidence shows ESG does not mean sacrificing returns. In fact, it is a return enhancer. In 2021, the New York University Stern School of Business surveyed over 1000 research papers analysing the relationship between ESG and financial performance. It identified a clear positive correlation between the two. The study concluded: “investors seeking to construct portfolios that generate alpha, some ESG strategies seem to generate market rate or excess returns when compared to conventional investment strategies.”

ESG also represents a changing mindset among investors and consumers which the investment industry would be unwise to ignore. New generations are more mindful of the world around them, from melting ice caps to social inequalities. This is impacting consumer patterns and investment products are no different. PwC has predicted asset managers’ total AUM invested in line with ESG will surge from $18.4trn in 2021 to $33.9trn in 2026. Allocations are continually growing throughout the industry, from small retail pots to major institutional mandates.

The challenges facing ESG in the current climate are significant, and further work is required to ensure investors keep the faith with the sustainability agenda and convert even more to the cause. But the world is changing and as wider society puts ESG front and centre, the investment sector will have to align itself with this long-term direction of travel.