It’s been a challenging year for investors and especially those with a sustainability-orientated remit. We explore some of the key drivers of this in 2022, and discuss whether structural attractions remain intact.
Recent years have seen significant growth in sustainability-orientated investment with several drivers lying behind this growth. Increased awareness of issues like climate change mean that more individuals are keen to ‘do their bit’, by investing in a way that seeks to avoid doing harm and/or drive positive change. Regulation is also providing impetus, increasing the prominence of environmental, social and governance (ESG) related issues and options in the financial advice process.
This growth in interest and assets under management has coincided with a period of strong performance from many sustainable investment strategies. It seemed that you could ‘do good’ without foregoing performance potential. 2022 has seen that trend reverse however, as markets have endured a challenging time and many sustainable strategies have lagged in relative terms.
Sector and style headwinds
There are many drivers of performance, but when assessing sustainable strategies in broad terms a couple of key themes emerge. The first is sector exposures in a year in which we’ve seen significant divergence between the winners and the laggards. If we look at the MSCI World, Information Technology – an area to which many sustainable strategies are overweight – is the standout positive performer over 3, 5 and 10 years. In recent months however, it has lagged considerably – as have the Healthcare and Industrial Sectors which are also typically well represented in sustainable portfolios. At the same time, the Energy sector has enjoyed a strong year of performance as the price of oil and gas has risen sharply thanks to the conflict in Ukraine. Exclusion criteria relating to fossil fuels means that the outperformance of Energy creates a stiff headwind to sustainable strategy performance.
Investment styles (or factors) have also played a considerable role in a year that’s seen a sharp rotation from ‘growth’ to ‘value’ – a shift prompted by the backdrop of high inflation and central banks tightening monetary policy. Sustainable strategies have an inherent bias towards ‘growth’, as well as a typical emphasis on ‘quality’ which has also underperformed as an investment style in 2022.
Thematic drivers remain intact
Such trends are obviously disappointing in the near-term but what about the longer-term prospects? We believe that there are many strong and persisting sustainability-orientated themes that offer real opportunity from an investment perspective. Oil majors may have performed well in 2022, but as the world transitions away from fossil fuels they are structurally challenged. Isn’t it better to invest long-term in businesses facilitating and benefiting from the energy transition trend? And what about companies that allow more efficient resource use, provide the tools for healthier societies, or make our buildings and cities more sustainable? Firms in these, and numerous other themes, remain well placed and many, after this year’s performance, look increasingly attractive from a valuation perspective.
The bias to growth looks set to remain a feature across sustainable portfolios but we expect them to become more balanced going forwards as more value tilted options emerge. These, as well as an ever-growing opportunity set, should see diversification benefits within sustainable portfolios increase over time.