Solution managers Mollie Thornton, Simon Molica and Joe Yallop look back at a tough year for ethical investing, and explain why the long-term outlook remains positive.
Since the end of 2021 and all through 2022, the prevailing macro environment has created challenges for all investors, particularly ethical investing.
Why has this year been so tough?
Firstly, persistent high inflation and central banks’ subsequent interest rates rises has led the market to favour value over growth investing. This has been detrimental to growth biased ethical portfolios.
Secondly, the nature of this underlying inflation (i.e. the surge in commodity prices exacerbated by Russia’s invasion of Ukraine), has meant that companies considered “unethical” such as in oil & gas, aerospace and defence have performed strongly. Ethical and sustainable portfolios have zero or very limited exposure to these areas, and have greater exposure to alternative energy and technology, which have underperformed over the past year.
Lastly, many ethical portfolios invest in companies providing solutions to environmental and social challenges, which tend to be in the mid and small cap market areas. These companies are generally not favoured when the economy enters a slowdown phase.
In short, the inherent biases within ethical solutions have led to significant headwinds throughout 2022.
A short-term blip?
While markets go through different phases, it’s important to remain focused on the longer term. Ethical portfolios have significant long-term structural themes which should benefit this type of investing.
There are still huge opportunities for investing in companies at the forefront of the structural changes in the economy. For example, McKinsey predicts we’ll need c.$10 trillion p.a. globally to transition to a net zero economy by 2050(1). This requires huge investment from both the public and private sectors. Similarly, a growing global population will need ever more sustainable food sources, and an ageing population will require advances in healthcare.
In our ethical solutions, we currently have exposure to companies providing solutions to these challenges. These include solar, wind and hydrogen companies within the renewable energy sector, as well as those involved in electric vehicles and the related supply chain. There’s also meaningful exposure to healthcare. Many of these companies have been hurt in share price terms in 2022, but their strong long-term prospects have not changed.
Political regulation is another tailwind for ethical investing. Nearly 200 countries, responsible for over 90% of global GDP, have signed up to the Paris Agreement aiming to transition the global economy to net zero by 2050. Similarly, at the national level, policies such as the US Inflation Reduction Act and the UK and EU Green Taxonomies will incentivise hundreds of billions into sustainable investments.
The companies benefitting from this will become the leaders of tomorrow, and being on the right side of that transition creates plentiful opportunities for investors.
Most importantly, individual investors increasingly want their portfolios to reflect their sustainability preferences. In a recent FCA survey of consumers with retail investment or pension products, 80% of respondents wanted their money to ‘do some good’ while also providing a financial return, 71% wanted to ‘invest in a way that is protecting the environment’, and 71% would not put their money into ‘investments which are unethical’(2). Despite the challenging market environment during 2022, the share of advised client assets in sustainable portfolios rose from 18% to 22% between Q1 2022 and Q3 2022, and clients are increasingly asking their advisers about sustainable investing (3).
We expect the new sustainable investment labels and disclosure requirements that the FCA is consulting on to provide greater transparency around funds’ sustainability objectives and evidence for how they are achieving them. This should give retail investors more confidence to align their portfolios with their sustainability values.
Looking to the future
Despite such a challenging year, we remain confident in our ethical investing outlook. It’s important to remember that any investment comes with risks and the potential for periods of short-term underperformance. While many investment trends and fads can quickly appear and disappear, ethical investing is intrinsically linked to a move towards lifestyle changes essential for a positive future. Humanity is relying on innovation and adaptability, and this is where ethical, sustainable and responsible investing shows its strength.
Our fund managers are committed to investing in high quality, sustainable companies offering exposure to long-term structural trends. Parmenion delivers four different profiles of ethical investing within our active solutions, so clients’ beliefs and values can be closely aligned to their investments. While 2022 has been a disappointing year, the long-term prospects for our ethical and sustainable solutions remain positive.
This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity.
Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.