ESG investing involves environmental, social and corporate governance parameters that allow investors to select companies that seek solutions to the world’s challenges while delivering returns similar to traditional investments. Companies taking an ESG approach strive to reach financial goals through ethical business practices.
Investors are increasingly choosing ESG criteria, according to a study of more than 1,000 global investors commissioned by Capital Group. Of those investors, 89% had adopted ESG in 2022, up from 84% in 2021.
What’s in store for ESG investors in the near future? Here are the top ESG trends to watch for in 2023, according to industry experts:
- Headwinds for 2023.
- Greater regulatory oversight.
- Increased impact investing.
- Emphasis on DEI.
- Biodiversity as “The New Climate.”
Headwinds for 2023
Recent events, such as the Russia-Ukraine conflict and the continued strength of energy and defense companies relative to the more ESG-friendly tech companies, turned 2022 into a hard year for ESG funds. Many of the biggest ESG funds lagged broader, non-ESG indexes during the year. The Vanguard FTSE Social Index Fund (ticker: VFTAX) lost 24%, for example, while the S&P 500 lost about 19%.
“The environment is further exacerbated by the increasingly skeptical rhetoric around the merits of ESG investing, which is likely to continue as a result of greater oversight and pushback from conservative states and a GOP-led House,” says Whitney Sweeney, investment director of sustainability at Schroders. She expects these headwinds to persist into 2023.
This “less supportive environment” will likely impact passive ESG funds, which rely on third-party scores when selecting companies for their portfolios, more than actively managed funds, she says.
This doesn’t mean investors should abandon ship, however. “The transition to a more sustainable economy will create opportunities and risks that are not captured by traditional investment analysis, so measuring and understanding ESG is critical for delivering value,” she says.
Greater Regulatory Oversight
Investors can hope for, and expect, greater ESG oversight in 2023.
“The interpretation and application of ESG investing has varied across the industry in ways that have left ESG investors without clearly defined criteria around what constitutes an ESG investment or how that investment contributes to social and environmental outcomes,” says Meredith Heimburger, partner and head of impact investing at Global Endowment Management.
As investors demand more clarity and transparency concerning investment products that claim to follow ESG practices, expect to see a rise in government regulations introduced in 2023.
“In 2021 alone, there were more than 225 new or revised policy initiatives established globally with an ESG focus – the highest number ever recorded and more than double any previous year,” Heimburger says. “We expect to see similarly high numbers for 2022 as the final tally is recorded and a continued high level of activity into 2023.”
Look for proposals related to company and product disclosures to help investors identify what they’re investing in, as well as a classification system to create a common understanding of just what “sustainable” is.
Sweeney says investors can also look forward to more ESG options in company-sponsored retirement plans following the final ruling from the U.S. Department of Labor on such practices.
Increased Impact Investing
Investors may have some lingering confusion about ESG. While the strategy is positioned as investing for the greater good, it is, in actuality, a framework to help investors evaluate the risk level of a company’s environmental, social and governance practices. ESG investors choose higher-scoring ESG companies because they believe this will reduce their overall portfolio risk, not necessarily to better the planet.
“As the industry grapples with how to course-correct on ESG, impact investing continues to emerge as a clearer and more intentional approach to portfolio development that drives positive impact for people and the planet without sacrificing financial returns,” Heimburger says. Impact investing uses “a rigorous and consistent measurement framework that provides investors with clarity and confidence around how their investments can deliver meaningful, positive impact.”
Emphasis on DEI
“Data demonstrates that diverse teams outperform their homogenous peers. This has been true for investment funds and firms, and public companies,” Heimburger says. “However, 99% of institutional assets today are invested by predominantly white, male teams.”
Given this, there is “significant opportunity” for investors in strategies led by or driven by solutions for greater diversity, she says.
An increase in ESG strategies focused on diversity, equity and inclusion, or DEI, is expected in 2023, says Sumali Sanyal, managing director and senior portfolio manager of the Systematic Global Equities Platform at Xponance.
“In the U.S., most workers will soon be people of color,” she says. “It therefore becomes increasingly important for companies to consider how DEI factors into their employee base and in their search for new talent.”
Biodiversity as “The New Climate”
Human diversity gets a lot of press in ESG spheres, but there’s another type of diversity that deserves equal attention: biodiversity, or the variety of life on Earth.
“The impact of reducing biodiversity loss cannot be underestimated,” says Elena Tedesco, a portfolio manager within the Listed Impact Team at Vontobel Asset Management.
Biodiversity is essential to creating balance and supporting life on this planet. It’s so important, Tedesco says, that some believe biodiversity may be “the new climate.”
“This is because many of the SDGs (U.N. sustainable development goals) can’t be achieved without preservation or restoration of biodiversity, including climate goals, which have already gained world attention,” she says. “Hence, there is a need to take some urgent action in favor of natural ecosystems, and for governments to adopt incentives to reward protection and conservation and to penalize offenders.”
This political attention could lead companies to alter their practices, too. “We have seen it before with incentives for clean energy, for instance, and this changed the name of the game for investors,” she says. “If history repeats itself, biodiversity-centered solutions could be the place to put your money with a long-term view.”
Her team has a positive outlook for companies engaged in reducing plastic waste, such as Smurfit Kappa Group PLC (SMFKY), a packaging company that provides paper-based options made primarily with recycled fiber.
Another company she highlights is Clean Harbors Inc. (CLH), which collects and recycles used motor oil to be used as lubricants. “Its lubricants do not require extraction of new fossil fuel, and it helps to prevent the release of hazardous waste into the environment,” she says.
“By investing in problem-solving companies that focus on material improvements, reuse and recycling, and end of life (and) waste processing, investors can reduce biodiversity loss while potentially achieving long-term growth opportunities and strong financial returns,” she says.
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