ESG Investing Trends: Capital Flow into Sustainability (ETFs)
ESG investing is about investing in tangible progress towards sustainability and other positive societal impacts – while simultaneously recognizing that companies seeking to fix the largest problems are the ones most likely to achieve outsized growth.
Investors focused on ESG gain a more detailed understanding of the companies to which they allocate capital and seek to confirm that their values align.
Based on the investor’s personal values (or that of their clients), the screening process integrates ESG into the investment decision.
A considerable amount of capital has been reallocated since society appears to be on the cusp of a transformative era and a structural shift towards sustainability.
Approximately $120 billion in capital poured into ESG-oriented ETFs in 2021, making it a record-breaking year for sustainable investing.
ESG ETF 2021 Flow (Source: Bloomberg)
Most of the largest institutional investors have publicly announced their intention to incorporate ESG metrics into their portfolio allocation strategies.
That said, the ongoing shift toward ESG and sustainable investing can potentially bring profound implications to consumers and companies alike.
- Environment: What positive (or negative) impact does the company have on the environment?
- Social: What social impact does the company have not just within itself (i.e. employees) but on the broader community?
- Governance: What initiatives have the company’s board and management taken to improve transparency and trust with its stakeholders?
ESG ETF Returns: MSCI ESG Leaders Index Performance
Contrary to a common misconception, ESG investing does not necessarily prioritize environmental, social, and governance impacts over returns, i.e. a trade-off between “ethical” investing instead of higher returns.
But rather, ESG is rooted on the basis that the two are not mutually exclusive, i.e. targeted returns can still be met while caring about ESG factors.
In fact, companies proactively fixing environmental, societal, and corporate governance issues can profit over the long run and are not typically placed at a disadvantage by any means.
For example, the MSCI World ESG Leaders Index is a market capitalization-weighted index consisting of companies with high ESG scores relative to their peers.
The difference in returns compared to MSCI World (i.e. the broader market) is negligible, as shown in the graph below.
MSCI World ESG Leaders vs MSCI World Performance (Source: MSCI)
ESG Ratings Scorecard: Rating System (Laggards, Average and Leaders)
After an in-depth evaluation of a company and its resilience (or weakness) to certain long-term risks, MSCI classifies companies into three distinct tiers:
- Laggards: CCC, B
- Average: BB, BBB, A
- Leaders: AA, AAA
ESG Rating (Source: MSCI)
ESG Investing Market Outlook
Considering how ESG data collection tools continue to improve and more ESG mandates are expected to be enforced, the continuation of capital flowing into ESG appears inevitable.
Formerly, firms seemed wary of strictly adhering to ESG standards, but the overwhelming demand from investors seems to have led to the normalization of sustainable investing.
Companies committed to addressing urgent ESG issues are better positioned to realize greater returns in the future for their long-term shareholders, as many of these concerns, such as environmental sustainability and other important societal goals, will only rise in importance over time.
Why? One aspect of achieving long-term, consistent returns is capitalizing on developing trends – and ESG is a major societal shift.
For instance, a startup focused on environmental technology now has a better chance at raising capital from outside investors than ever before, which can further inspire more startups to join in on fixing the same (or adjacent) problems.
