What could be behind the rising interest in sustainable investing?

WHEN TALK TURNS TO INVESTING these days, you may increasingly hear about “sustainable investing”. There’s a reason for that: The approach – often described as “investing with the goal of benefiting people, the planet and portfolios” – has been on a tear.

That’s certainly reflected in the volume of assets involved.  For 2020, flows into open-end and exchange-traded funds available to U.S. investors that take data on environmental, social and governance (ESG) factors into account were $51.1 billion, more than twice the volume for 2019 and a nearly tenfold increase over 2018.² For the first three quarters of 2021, the U.S. sustainable fund landscape saw $54.7 billion in net inflows.³

Additional growth arises from the expanding array of choices investors now have to access investments with a focus on sustainability, which include individual equities, green bonds, index-linked funds, and many more.

And while women, high-net-worth individuals and especially Millennials have been at the forefront of the movement, sustainable investing is gaining traction among a wide range of investors. A survey of financial advisors by Nuveen found that the three generations most likely to ask about sustainable investing were Gen X, Baby Boomers and Millenials, in that order.⁴ Based on those demographic trends, we believe the momentum behind sustainable investing should continue to build well into the future.

What’s behind this broad expansion? Here are some of the factors as we see them.

Investing in what matters most to you …
These days we’re all more aware of critical issues facing humanity: climate change, health care, how employers are providing safe and secure working environments and benefits like paid leave, to name a few. Investors may be looking for companies that are taking steps to find solutions to these types of challenges—such as reducing their carbon footprint or expanding the diversity of their board—while avoiding or divesting from those that are not. In this way, investors can honor their personal concerns, in effect aligning their portfolios with their values.

… while also focusing on potential returns ...
In a stark contrast to the recent past, when values-based investors might have expected lower returns, we have seen ample evidence that corporations scoring high on an “ESG  scorecard” may perform as well as or even better than the broader market.⁵ When looking at the financial analysis of securities, BofA Global Research found that risk-adjusted returns were enhanced by combining traditional factors with ESG information (See chart).

The evidence can help make investing sustainably seem like a clear choice. Or, in the words of Jackie VanderBrug, head of Sustainable and Impact Investment Strategy in the Chief Investment Office for Merrill and Bank of America Private Bank, “If all things are equal in terms of risk and returns, the real question investors might ask is, why not add a sustainability lens to your portfolio and invest in companies that are potentially poised for longer-term success?”

…and keeping an eye on risk
In addition to evidence of competitive returns, the desire to manage risk has driven interest in sustainable investing, according to Anna Snider, head of Due Diligence in the Chief Investment Office for Merrill and Bank of America Private Bank. “Looking at a company’s ESG data may also help investors spot potential problem areas—and understand their consequences. They can then use that information to help manage risk in their portfolios.” What would they look for? If a company is failing to provide safe conditions for its employees, it may find itself unable to operate due to regulatory constraints. A corporation that’s failing to address gender inequality could potentially be sued by employees.

Understanding these issues of ESG mismanagement is important as they may lead to a decline in asset value—including a company’s share price. MSCI found that the stocks of companies in the top quintile for ESG factors overall, and for the E, S and G factors individually, experienced fewer major drawdowns than the bottom-scoring quintiles, and the top and bottom quintiles experienced the biggest difference in drawdown frequency at the tail.⁶

Corporate reporting has expanded
Another factor behind the growth in sustainable investing is that more and more companies are releasing ESG-related information—on waste management, diversity and inclusion, raw materials sourcing, and the like. There is not yet a set of regulatory guidelines for the kind of data that companies should report, but with the growing embrace of voluntary reporting standards, corporate transparency has improved substantially in recent years, allowing investors and independent rating agencies to form increasingly reliable views about the risks and potential opportunities associated with ESG issues and their effect on company performance.

How you can learn more
Sustainable investing has evolved substantially over the past decade, and more investors are realizing the potential it offers to pursue their values while also seeking competitive returns and gaining insight into exposure to ESG risks. At the same time, more companies are getting on the bandwagon and are making data available on their environmental, social and governance record, with much of it compiled and checked by independent third parties. We believe this evolution makes sustainable investing compelling to consider. For more information, read our updated report “Performance Realities: Revisited,” and speak to your advisor about whether this approach makes sense for you.