Solution managers Mollie Thornton, Simon Molica, Mark Foster and Joe Yallop looked back at 2023 to consider whether ethical investing has turned a corner.
Their conclusion: a long-term outlook that remains very positive, supported by inflation rolling over and increased regulation helping transparency.
Mollie Thornton: Throughout 2022, the prevailing macro environment created challenges for all investors, but particularly for ethical investing. While 2023 brought its own challenges, signs during the last 3 three months of the year demonstrated what could be in store if inflation continues to come under control. We think falling interest rates could create a very powerful tailwind for this style of investing. Long term investing is about staying the course and we urge investors not to panic and crystalise losses at the wrong time.
Simon Molica: Agreed. Another tough year for ethical investing, but green shoots are definitely appearing… For most of 2023, the spotlight remained firmly on inflation, which fell slowly from its peak creating similar conditions to those experienced in 2022. So from an equity style perspective, value outperformed growth, which again proved problematic for ethical investors.
An exception to the rule was the United States, where growth flourished, but sadly not to the direct benefit of ethically orientated stocks. The rally was narrow and driven by a small collection of large US technology stocks with exposure to the AI movement, now known as the ‘Magnificent Seven’. While there is exposure to these companies in ethical funds, some companies such as Meta Platforms are excluded because it presents an array of interesting ESG challenges.
Mark Foster: Another challenge to ethical stocks during the calendar year, again in a similar vein to 2022, was large cap versus small cap. With companies providing solutions to environmental and social challenges tending to be in the mid and small cap market areas, inflationary pressures and global economic slowdowns combined meant this area of the market came under pressure and failed to keep pace with their larger cap counterparts. However, small and mid caps now appear to be at very attractive valuation levels, and experienced a strong end to the year as interest rate cuts began to be priced into the market.
Mollie Thornton: And the good news is that inflationary headwinds appear to have abated. Stubbornly high inflation has been a major factor in the performance challenges over the past 2 or so years, because of the inherent style biases within the Ethical solutions.
However, with inflation numbers falling more than expected, our Ethical Active solutions performed rather well over the fourth quarter, illustrating the point about the headwinds up to now. As the regime changes once again, we’re excited about the return potential going into 2024.
Mark Foster: I’m particularly excited about the growing number of opportunities across the Ethical investment spectrum. From its niche origins, the universe for ESG options is rapidly expanding across a range of asset classes. This year we’re looking closely at the issuance of global bonds that require funding for specific environmental/social purposes or are structurally linked to a company’s wider climate goals. Bonds offered by supranational organisations like the World Bank also bear consideration, although thorough analysis is needed to make sure these bonds are living up to their claims.
Simon Molica: More ‘value-oriented’ ESG equity funds are also coming to market, and these pay greater attention to stocks trading at a relatively low price compared to earnings. This is a great style diversifier, helping reduce bias within portfolios and hence supporting more consistent returns throughout the economic cycle. Elsewhere, opportunities remain in renewable energy, boosted by a COP28 agreement to triple production and producers pushing back on price.
Mollie Thornton: It’s been a very busy year for our in-house team and our independent Ethical Oversight Committee (EOC) members too. In total, our EOC members held more than 25 meetings with fund managers to research a range of active and passive funds across different asset classes in detail.
The outcome of these meetings was to reaffirm our conviction in many of the existing funds in the solution, although we did remove a small number of funds and introduce seven new funds, all of which we believe will further enhance the alignment with the ethical mandate.
Joe Yallop: The themes managers look at are also widening in scope, and this year I’d like to see a renewed focus on nature, with efforts to protect biodiversity and prevent deforestation. This will be aided by the proposed new guidance around nature-based disclosures and an international-agreement to reverse biodiversity loss.
Mollie Thornton: Given a difficult period for performance and more attractive cash rates, it’s not surprising that flows into ethical and sustainable funds declined last year. However, according to latest data from Morningstar, flows did continue to be positive ($13.7bn in Q3 2023) while the non-ESG universe suffered outflows*. This reflects the continued client appetite for funds which reflect their values and integrate ESG and sustainable criteria.
Mark Foster: Beyond client demand, regulation is another area increasing in importance. The publication of the SDR (Sustainability Disclosure Requirements) policy statement in November last year is the latest example of this, to be implemented during 2024. This will have continued influence on the asset management industry as a whole and includes improvements in standards of marketing and literature, before the introduction of four sustainability fund labels from July. You can read our view on the new requirements here.
Joe Yallop: And then there is obviously the long term trend of our transition to a low carbon, sustainable economy. The continued extreme weather during 2023 clearly demonstrates the impact of climate change and the untold devastation that the Earth has already sustained. The all-visible carbon clock counting down the carbon budget is fast approaching zero - the wake-up call to promote global initiatives in tackling the world’s problems.
Simon Molica: As each year passes, the issues are becoming more and more pressing and the demand is increasing to find solutions, which will require collaboration and funding from both the public and private sectors.
Mollie Thornton: As a team, we remain confident in the long term outlook for ethical and socially conscious investing, driven by long term trends, the shorter term improvements in the macro environment and increasing regulation. Following a challenging period, we hope that the final quarter of 2023 is the shape of things to come.
Sources: Global_ESG_Q3_2023_Flow_Report_final.pdf (contentstack.io)
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