Making money and saving the human race: ESG investing comes of age

Daniel Harman

By Daniel Harman, co-founder of Darksquare

Interest in Environmental, Social and Governance (ESG) investing continues to grow. According to one survey, the past four years have seen an 80% boost, while 2022 saw a rise in the number of ESG funds achieving Article 8 classification.

Most businesses now have ESG policies, sustainability plans and commitments to be as environmentally friendly as possible. It’s often harder to find a company that doesn’t want to discuss its ESG credentials.

The maturing of ESG

Cynics will say that they, and the investors backing them, are merely jumping on bandwagons and would point to accusations of greenwashing and disclosure failures as proof. Yet to dismiss this as pandering to public demand for climate action is to miss a broader point that, whereas ESG initiatives in the past might have been lightweight, they are much more mature now. As a JP Morgan Study noted, “investing in ESG is established in Europe”.

What’s driving this? The same study found that end-client demand was driving investments in ESG, with investors aligning personal beliefs and positively impacting their own investments following closely behind.

However, this isn’t an exercise in investors or clients simply wanting to feel good – 27% highlighted improved returns as the most common reason to make an ESG investment.

What do those returns look like? According to one report, stock funds weighted towards companies with positive ESG scores outperformed globally over the last five years, with those in Europe and Asia-Pacific doing best.

The impact of changing demographics

In addition to that, the changing demographics could well help propel ESG investing to new heights. One survey found that three-quarters of Generation Z and Millennials already have or would invest, dropping to 60% of baby boomers. At the same time, another survey revealed that 82% of Gen Z and nearly two-thirds of young millennial investors have ESG investments compared to 41% of those aged 45 and older.

Of course, ESG is a broad church, covering a huge array of different initiatives and opportunities. There will be some within the spectrum that do not perform as well as others. There’s also a tendency, as ESG is a relatively new area of investing, to presume that asset classes within the field are themselves new. Yet some of the best-performing ESG asset classes have long been a source of income.

How an ancient asset out-performs cutting-edge tech

One example of this asset, and one that is doing well, is forestry. In 2021, a bumper year generally for ESG, UK forestry outperformed the S&P 500, FTSE 100, UK investment grade bonds and even property to return 33%. While spectacular, that wasn’t even a one-off – over five years, it returned 22%, dropping to 19% over 15 years.

Forestry’s output is timber, and it’s true that with timber mainly used in construction, economic slowdowns can hit prices. However, trees don’t stop growing just because the economy does. Once mature, they often have a 15-year harvesting window, meaning owners can wait until prices recover.

Let’s be clear; new technology has to solve some problems. Whether it’s using data to optimise shipping fuel efficiency, developing new ways to recharge electric vehicle batteries or deploying blockchain-based applications to safeguard data governance, many ESG investment opportunities utilise cutting-edge technology. What forestry’s ongoing performance does show, however, is that for those investing in ESG, there are significant opportunities to be found.

The need to broaden access

There will be bumps in the road, of course. One of them is access – forestry, for example, rarely appears in stocks and shares individual savings accounts (ISAs) or one of the other vehicles individuals can use to invest with. Outside of the aforementioned equities, ETFs and cryptocurrencies, investment opportunities for people not in hedge funds or Ultra High Network Individuals (UHNWIs) are limited. The appetite is certainly there: 80% of those aged 40 and under and 89% of those aged 30 and under plan to invest in more asset classes in future.

Broadening access allows more people to invest and means more opportunities for companies to secure funding and backing. This compels peers and competitors to improve their ESG credentials, as they realise both the benefits (more financing) on offer and challenges (more scrutiny) lurking.

That’s why it is likely that ESG-focused investing will grow in the mid to long term as all sides realise the benefits. Companies will strengthen their ESG credentials, ESG-focused businesses will continue to grow, and investors and end-clients will enjoy more ESG options.

About Author:

Daniel Harman is the co-founder of a company called Darksquare, a platform which gives individuals access to alternative investment products. Prior to founding Darksquare, Dan was a Distressed & Special Situations trader at RBS, managing ~£600m of bonds, loans, unlisted equity and CDS. Before that he worked in Investment Banking, focussed on originating bonds for Investment Grade European Corporates. Dan Studied Economics and Politics at University and holds an MSc in Finance and Management, both from the University of Exeter.