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“Green” trends in 2022

The three letters E, S and G have long since gone mainstream in the investment world, but the sustainable investing space remains a dynamic (growth) market. We shed light on some “green” trends that look set to continue this year.

 

Carrot and stick

Sustainable investing continued to gain popularity in 2021. Morningstar calculates that total assets under management in investment funds and ETFs categorized as sustainable more than doubled over the first three quarters of 2021 alone to a worldwide volume of USD 3.9 trillion. Almost 90% of those assets are domiciled in Europe. The torrid growth momentum (and heavy regional skew) in 2021 was particularly caused by the wielding of a regulatory stick called the Sustainable Finance Disclosure Regulation (SFDR), which since March classifies investment vehicles in the EU into a “conventional”, “light green”, or “dark green” category. The introduction of the SFDR prompted many investment funds to “adjust” their stated objective so that they can now be deemed sustainable. This adjustment procedure looks set to continue in 2022 because around half of all assets under management in European mutual funds basically qualified for inclusion in the green categories. However, the fact that ESG investments appear destined to continue outgrowing conventional investments does not owe solely to the stick, but also to a carrot. According to a study by investment consultancy Bfinance, around 80% of the investors surveyed expect sustainably managed strategies to (continue to) outperform over the next three years. This bullish expectation is also bound to give “green” assets further buoyancy in the quarters ahead and shows, last but not least, that ESG investing has long since gone mainstream, a fact that was reflected again in 2021 by the many new signatories to the Principles for Responsible Investments (PRI) initiative.

 

Unabated momentum
Continually growing investor community

Assets under management and number of signatories to PRI initiative

Source: UNPRI, Kaiser Partner Privatbank

 

Peak greenwashing?

The rapid growth of ESG investing in 2021 was accompanied by discord because although there was a lot of successful tub-thumping of green investment vehicles in the media, critics of the sustainability trend were also allowed to get a word in more often than in previous years, and many of their admonitions warned against greenwashing. It thus far really has been easy to put a green stamp on an investment product because the alphabet soup of ESG regulations, terminologies and labels is hard to decipher. If you ask ten portfolio managers to define what a “green investment” means, you will still get ten different answers today. However, it is gradually becoming foreseeable that a common vocabulary will evolve that will foster transparency and above all will likely make it easier to select green investment products. The US Securities and Exchange Commission (SEC) has already called the investment industry’s attention to shortcomings in ESG data disclosure and verification practices, and further steps are likely to follow. In Europe, meanwhile, the SFDR cited above already represents a major advancement. According to a study by MSCI, (climate) funds that are marketed as sustainable investment vehicles pursuant to Article 8 or Article 9 of the SFDR are better aligned with a 1.5°C or 2°C global warming scenario than conventional mutual funds are. Moreover, their ecological footprint is generally smaller, with statistical significance. The SDFR thus makes it altogether more difficult for an investment fund to engage in greenwashing and, conversely, makes it easier for investors to comprehend the green nature of an investment and to pursue personal sustainability objectives. The EU Taxonomy Regulation that took effect on January 1, 2022, should also provide a clearer answer to the question of what truly qualifies as being sustainable. The taxonomy spells out which economic activities are considered “green” and sets reporting requirements for (European) companies. It could contribute to creating an international standard for defining sustainability issues. There are already signs that the EU taxonomy looks destined to develop into a set of guidelines that other countries will use to define their own frameworks and which investors can use to implement their sustainability strategies.

 

(Dark) green funds…
…really are somewhat greener

Implied temperature rise in climate fund portfolios

Sources: MSCI, Kaiser Partner Privatbank

 

Net zero across the supply chain

“Net zero” was one of the key catchwords in the ESG world in 2021. Many governments vowed to cut their countries’ greenhouse gas emissions to an even greater extent than previously planned. Many companies again rushed to disclose CO2 emission reduction roadmaps to the public, not least due to pressure from their shareholders. The US internet giants Amazon, Microsoft and Alphabet have long ranked among the trailblazers on the road to “net zero.” Their market clout has increasingly made them the target of criticism lately. But when it comes to achieving their very ambitious climate goals, size could prove to be a huge blessing for once because there is enormous potential to cut the CO2 emissions of cloud data centers, a market that is almost completely dominated by those three companies and which requires billions of dollars of capex each year. If Amazon and cohorts wish to improve both their direct as well as indirect ecological footprints, they will have to put corresponding pressure on their suppliers of technology equipment (hardware, semiconductors, etc.) in the future. They are more than likely to do that sooner or later. IT equipment manufacturers like Lenovo and Hewlett Packard and chipmakers like Intel and TSMC, which heretofore haven’t disclosed official net-zero targets yet, could soon see themselves forced to do so. We can expect to see similar greening effects across the supply chain in other industries as well in the years ahead.

 

“Private” emissions under close scrutiny

Just how intense the pressure on publicly traded companies – particularly those operating in “brown” industries like the basic materials and energy sectors – has become in the meantime was demonstrated last year by events that included small activist investor Engine No. 1’s surprise victory in its dispute with oil giant Exxon Mobil. Many a corporate leader might very well imagine here that life is much calmer away from the financial markets – tucked in the bosom of a private equity firm, for example. And in fact, even the giants among publicly traded private equity firms have at most heretofore reported only on their own ecological footprint. Apart from Sweden-based EQT, none of them disclose information about their portfolio companies’ emissions. Their (marketing) focus instead is (still) on playing up the success stories of select companies or highlighting investments in renewable energy in general. Over the last ten years, publicly traded corporations have learned the hard way – quite painfully in some cases – that this “tactic” of citing anecdotes instead of referencing systematic, quantitative reporting no longer satisfies investors, regulators and other stakeholders. Private equity firms likewise won’t be able to duck out on improving their communication practices for much longer. Investors also on private markets will likely soon start to demand stepped-up disclosure of standardized metrics that cover the entire spectrum of climate risks and detail the alignment of portfolio companies with a 1.5°C global warming scenario.

 

Oliver Hackel, CFA Senior Investment Strategist

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