Environmentally and socially responsible strategies do not guarantee per-se a positive financial performance. Comparative returns analysis has shown that a company particularly attentive to ESG criteria not only has a lower risk of incurring into frauds, scandals, sanctions and reputational damages, but on the long term these companies are being also recognized by investors and by their valuations. In particular, sustainable investment linked to environmental themes (e.g. renewable energy, circular economy, and Green Bonds) have been able to generate interesting returns, especially following monetary stimuluses implemented by central banks and fiscal-budget supports provided by country governments around the world following COVID-19 crisis.

Nevertheless, these strategies were negatively impacted by significant drawdowns in the last two years. Sectors as energy, defense and utilities were among the winners of this equity market period, as the rate hikes seriously affected the market valuations of the growth-biased energy-transition companies, which represented the majority of the major ESG strategies available in the market.

There are few factors which contributed to this negative momentum. In addition to the adverse macroeconomic framework, related to still elevated interest rates to face inflation and the recent monetary policy tightening from central banks, and to market multiples repricing after the post-COVID rally, also geopolitical factors contributed to sustain “old economy” sectors and their relative outperformance compared mostly to clean energy investments.

As a result, empirical evidence demonstrates that the main ESG equities indexes have under-performed the corresponding non-EGS benchmarks over the last two years. As an example, MSCI World ESG Leaders index has under-performed the traditional MSCI World by approx. +2,80% over this time period, while in Europe the ESG index still delivered a +1,30% higher return than MSCI Europe.(Source: Bloomberg data).

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Figure 1 : Equity ESG vs Non-ESG Indexes

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Nevertheless, ESG investments has recently faced some challenges also in Europe. ESMA recently released new rules to prevent greenwashing attempts and to ensure that sustainable labelled funds are concretely implementing sustainable investing. Regulatory environment pushed data disclosure spread and taxonomy is supporting asset managers to increasingly apply ESG analysis screenings. Nevertheless, we have been experiencing a wave of managers downgrading funds amid uncertainty over their status. In this regard, strategies with a quantitative method to measure their SDG alignment could be a common framework for investors to ensure selecting true sustainable investments.

Worth to mention, SDG themes are separate from ESG themes, which play a much larger role in fund managers’ decision making. However, according to Lindsey Stewart, director of stewardship research and policy for Morningstar Sustainalytics, cit.: “If the SDGs represent the destination, as agreed by the U.N.’s member states, then the metrics that indicate progress on ESG themes are important mile markers on the route. If you don’t see those, you’re probably on the wrong highway,” he wrote in an article in September.

Luxembourgish kept its role of pioneer in the sustainable fund industry, as proved by the fact that, according to a Morningstar research, four out of ten of the largest European SDG focused funds are based in Luxembourg, and also the start of the interest rate cut cycle could further support the recovery of sustainable investments in the short-to-medium term.

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If you want to learn about our sustainable investing products and services offering, please contact CRM@FARAD-IM.com.

 

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