How sustainable is ESG?

We look at why the recent boom in ESG fund popularity is here to stay, and how advisers can navigate the challenges of this brave new world.

The popularity of ESG funds has surged in recent years. Salient realities such as the pressing climate crisis and Covid-19 pandemic have raised public awareness of ESG issues, while ESG investment choices have been taken to whole new heights.

Scepticism about whether ESG funds can truly deliver the same returns as their non-ESG competitors seems to have been finally put to bed. Positive impact funds have started to demonstrate they can more than hold their own, if not beat, many of their rivals – with some ESG products becoming a first-choice investment based on performance alone.

All of this, combined with a new generation of ethically conscious investors with easier access to investment products and platforms, has served as a heady tailwind for today’s booming ESG funds industry.

Here to stay

As with any trend though, there is always the fear it is just that – a passing fad. Just how sustainable is the ESG phenomenon?

Thankfully, there’s much to suggest that ESG is far from fleeting and is instead an enduring trend that’s here to stay. Only 13% of investors think ESG will eventually go out of fashion, according to research from Capital Group, while the number of ESG-aligned products coming to market is rising – and fast.

Investment managers everywhere are launching new funds and re-positioning existing strategies, whether with ethical exclusions or for social impact. This is creating an abundance of choice for investors and a large market hungry to receive capital.

Increasing regulation is also indication of a robust future. Stronger scrutiny, standards, and transparency will help root out ESG imposters and reduce problems such as greenwashing and carve out a lasting place for ESG products. Clearer definitions and guidance from the FCA will also help raise adviser and client confidence in ESG funds.

Statistic source: GSIA

Slow down, speedbumps ahead…

However, the ESG sector is not without its dangers. The growth of ESG is undoubtedly a good thing, but this burgeoning sector is still finding its way and there are many questions to be addressed.

The onset of geopolitical tensions and inflationary pressures have laid bare new-found challenges for sustainable funds. The war in Ukraine has recently shaken up the consensus of companies’ ESG credentials, with governance coming under the spotlight more than ever before. Such global issues create new dilemmas for advisers and their clients. For example, can defence stocks, once the bogeyman of any ESG portfolio, now be regarded as having social value because of the protection and deterrence they can bring?

Meanwhile, growth investing tailwinds – which have so far benefited many ESG products – are starting to reverse as inflation proves to be far more than transient. And as the short-term performance of many ESG funds comes under new pressure, past concerns regarding positive impact only coming at the expense of performance could start to re-emerge.

What to tell clients

With all this to consider, what should advisers be telling their clients?

Advisers must stay up to date with the ever-evolving ESG landscape if they want to benefit from this growing sector. Furthermore, advisers must make sure clients aware of the dangers mentioned above. This is not to say ESG should be discouraged – but it’s important clients understand potential pitfalls and nuances, from shifting expectations and greenwashing threats, to how the objectives of ESG product types differ.

Finally, advisers must consider the pros and cons of creating a mixed portfolio. Such diversification enables clients to be exposed to ethical strategies that fit their values, while being protected by the safety blanket of traditional fund solutions.

These conversations can help advisers and their clients arrive at informed decisions that match their individual financial goals, ethical considerations, and risk appetite.

UK investment source: refinitiv

A changing world

From an evolving regulatory environment to a well-stocked supermarket of products, ESG is here to stay and it’s time for advisers to strap themselves in for the long haul.

ESG is not without its challenges, and there’s likely to be more speedbumps along the way as new macro environments and geopolitical realities emerge. But by staying informed of the latest developments and having open, informed conversations with clients, advisers will be able to navigate the changing ESG landscape with greater peace of mind.