Sustainable investing or investing in Environmental, Social, and Governance (ESG) factors is gaining ground in the financial markets. Despite the market selloff that punished many sectors, sustainable funds that invest based on factors such as companies’ carbon footprints and workforce diversity attracted new investment in 2022. With a flood of capital chasing greener investments in response to a warming planet, sustainable products are benefitting. Furthermore, governments and regulators are increasingly setting ambitious climate targets, pushing companies to shrink their carbon footprints. In this article, we will discuss sustainable funds, examples of sustainable investments, their performance, and whether they should be a part of your investment portfolio.
What is Sustainable Investing?
Sustainable funds are mutual funds and exchange-traded funds (ETFs) that integrate sustainable development-related considerations into their asset allocation process. As per the latest reports, the number of sustainable investment funds has almost doubled in the last five years, reaching 3,987 by June 2020, with assets under management (AUM) of over $1.7 trillion. Net investment flows to these funds reached $159 billion in 2019 and are estimated to surpass $300 billion in 2020. The sustainable fund universe includes 3,435 sustainable mutual funds and 552 sustainable ETFs, with AUM of $1.56 trillion and $174 billion, respectively. Equity funds account for about two-thirds of sustainable funds in both number and assets, with the remainder split between fixed income and mixed allocation funds.
What are Examples of Sustainable Investments?
Sustainable fixed-income funds sometimes buy green bonds and use climate and social scores from ESG raters to screen corporate issuers for risks, similar to equity-based funds. Some of the sustainable fixed-income funds with the largest inflows invest directly in renewable energy, low-carbon transit alternatives, and other sustainable projects. The Calvert Bond Fund drew in $413 million in investment in 2022, the third-highest inflow of any sustainable bond fund last year, according to Morningstar. The Hartford Schroders Sustainable Core Bond Fund netted $109 million last year despite underperforming its benchmark. Inflows were likely driven by investors reallocating capital into sustainable products with similar performance to conventional funds. Most sustainable funds underperformed their non-ESG counterparts in 2022, according to Morningstar.
How Many Sustainable Funds are There?
The sustainable investment market is growing rapidly, and this market has the potential to contribute to sustainable development through investments in sectors relevant to the attainment of the Sustainable Development Goals (SDGs), including in developing countries. Geographically, the majority of funds are domiciled in developed countries, particularly in Europe, and target developed regions in their portfolio selection. Developing and transition economies host about 5% of the world’s sustainable funds by number and less than 3% by assets.
Benefits of Sustainable Investing
Sustainable investing has several benefits, including:
- Positive Impact: Sustainable investing allows investors to make a positive impact on the world by supporting companies that are committed to sustainable practices.
- Long-Term Returns: Sustainable investing is often associated with long-term thinking, which can lead to better returns over time. Companies that prioritize ESG factors are often better positioned to succeed in the long run.
- Risk Management: Sustainable investing can help manage risk by avoiding investments in companies with poor ESG practices that may face negative consequences in the future.
Strategies for Sustainable Investing
There are several strategies investors can use to incorporate sustainable investing into their portfolios, including:
- ESG Integration: This involves incorporating ESG factors into traditional financial analysis to identify companies with strong ESG practices.
- Thematic Investing: This involves investing in companies that are focused on specific themes, such as renewable energy or sustainable agriculture.
- Impact Investing: This involves investing in companies and organizations that have a clear and measurable social or environmental impact.
Should I Invest in Sustainable Funds?
ESG investing is under pressure from all sides. Republicans are working to prevent investors from considering climate and social risks in their decisions. Investors and observers are increasingly scrutinizing the market as some offerings overstate their climate bona fides, also known as greenwashing. Last year, the Securities and Exchange Commission proposed tightening rules around ESG-related offerings that could lead to additional disclosures and product names that better reflect their mandates. It’s important to note that most sustainable funds underperformed their non-ESG counterparts in 2022. However, sustainable investing has its benefits. Sustainable fixed-income funds accounted for $2.4 billion of all sustainable investment inflows, or about 75%, a surprising performance given how rising interest rates have punished many bondholders. Sustainable funds have the potential to contribute to sustainable development through investments