ESG Investing Trends: Why It Matters?

Environmental, social and governance(ESG) are the core pillars of an investing strategy that has gained prominence in the global financial market in recent years. 

ESG investing evaluates or screens companies based on these three responsibility metrics as a standard to guide investment decisions with ethical and sustainable impact. It aligns financial goals with broader societal and environmental objectives, offering investors opportunities to support companies making positive social and environmental impacts.

Environmental criteria assess companies' ecological impact and sustainability. Social criteria gauge companies' community contributions, employee relations, race, gender, human rights, supply chains and customer interactions for transparency. Governance examines companies' leadership, shareholders' rights, executive compensation, audits, internal controls and oversight for accountability.

 Suppose you're a retail investor seeking societal well-being alongside profits. In that case, understanding ESG investing trends can help you align your portfolios with evolving societal values and norms.

It enables you to identify emerging opportunities and risks, ensuring you stay ahead of market shifts and make informed investment decisions. For fund managers and institutional investors, staying abreast of ESG trends enhances credibility and fosters stakeholder trust, ultimately driving long-term financial performance and sustainable growth.

Performance and Forecast

How are ESG Investments Performing?

ESG investments have shown strong performance across various asset classes, with growing evidence indicating that companies with solid ESG profiles tend to outperform their counterparts over the long term.

 A study by Morningstar found that over 10 years, more than 70% of sustainable U.S. large-cap equity funds outperform traditional funds. The same research revealed that 77.3% of ESG funds available 10 years ago have survived, compared to 46.4% of non-ESG or traditional funds. 

This boom is because of improved risk management, enhanced corporate governance and increased investor demand for sustainable and ethical investment opportunities. As the supply chain becomes more complex, there's a broader global awareness of social, labor and human rights issues and risks for the business world. 

Additionally, environmental issues like climate change influence investors' decisions. Solid performance across the three pillars of ESG is connected with value creation in multiple ways, as revealed in a McKinsey report. 

The report suggests that a high ESG score may result in increased revenue, reduced costs, fewer regulatory interventions, improved productivity and optimized assets. Another factor potentially driving the ESG investing boom is the rising involvement of previously underrepresented groups in investing, particularly young people and women.

Regulatory developments and shifting societal preferences also are driving greater integration of ESG considerations into investment strategies, further bolstering the performance and relevance of ESG investments in today's market.

What Is the Forecast for ESG Investments?

Despite recent polarized sentiments, cooling enthusiasm, macroeconomic challenges and a potential 70% slower growth, the ESG investments market is set to mature and align with global regulation by the end of this decade, according to Bloomberg Intelligence (BI). The market surpassed $30 trillion in 2022 and is forecasted to exceed $40 trillion in 2030. 

With investors emphasizing ethical considerations alongside financial returns, ESG integration is expected to become standard practice across asset classes, reshaping global investment strategies and capital flows. 

The 2030 forecast, based on BI's inaugural ESG Market Navigator, highlights that most investors (85%) perceive ESG as contributing to improved returns, more resilient portfolios and enhanced fundamental analysis. As the market matures, scrutiny and regulations are bound to tighten to enhance the credibility of ESG assets. 

The U.S. ESG investing trend may stagnate amid the upcoming elections and ESG backlash. At the same time, Europe will remain the most significant contributor. Emerging trends and expanding markets in countries like Japan, Canada and Australia could also contribute to future gains.

Current Trends

Is ESG Investing Still Popular and Growing?

Although ESG investment still surges in popularity, especially in Europe, it has lost steam, particularly in the U.S., where fund flows notched their worst year on record. In the fourth quarter of 2023, global sustainable funds experienced net outflows of $2.5 billion, marking their first entry into negative territory, according to Morningstar. Total outflows in the U.S. sustainable fund hit $13 billion as performance lagged behind traditional funds. Many factors are driving the decline. 

The high borrowing cost significantly impacts capital-intensive clean-tech stocks, and inflationary pressure exacerbates this trend. Such an uncertain economic environment heightens investors' appeal for traditional investments, diverting attention from ESG strategies. Additionally, greenwashing is a big issue. 

This involves exaggerating environmental achievements, using vague or ambiguous language, or focusing on minor or irrelevant environmental features to divert attention from more significant environmental issues. 

Greenwashing is deceptive and unethical because it misleads genuine ESG investors and undermines legitimate efforts to address environmental concerns. Recent regulatory concerns over greenwashing in ESG funds have shifted the issue from a marketing problem to a legal one.

For instance, in November 2022, Goldman Sachs agreed to pay a $4 million penalty to the U.S. Securities and Exchange Commission (SEC) to resolve charges stemming from policy and procedural failures in its ESG research. The same year, BNY Mellon was fined $1.5 million for misstatements and omissions related to ESG.

Perhaps the most notable issue slowing the ESG trend, particularly in the U.S., is politics, as rightwing populists mount a backlash against a business vision that looks beyond profit — the so-called war against "woke capitalism." Whether that is borne out of a genuine desire to root out the dark side of ESG investing or is driven by fossil fuel interests and allies, it seemed to have significantly dampened the ESG investment momentum and conversation around it.

 In 2023, BlackRock Inc. CEO Larry Fink announced a shift from using the term ESG, a trend seen across the institutional landscape. RBC Capital Markets data shows that 56% of new sustainable funds are now labeled “thematic” instead of “ESG,” with industry leaders noting politicization as a factor. This is more so as Republican lawmakers introduced 165-plus anti-ESG bills in 2023. 

While former President Donald Trump's environmental scorecard in his first term seems deceptively upbeat, most investors believe that might not be the case if he returns to the White House. The implication for ESG investing will likely be dire.

Trends in ESG Investment in 2024

In 2024, the landscape of ESG investing is witnessing several notable trends. First, there's a growing emphasis on impact measurement and reporting, with investors seeking more transparent and standardized metrics to evaluate ESG performance. There's also a notable shift toward thematic investing, focusing on sustainability themes such as clean energy, climate action and social justice. 

Regulatory developments are playing a significant role, with governments worldwide implementing stricter ESG disclosure requirements and sustainability mandates for corporations. The EU's Corporate Sustainability Reporting Directive (CSRD) compliance phase took effect in January 2023. The same month, the German Supply Chain Due Diligence Act (SCDDA) broadened its scope. The SEC is also expected to release its final rule on climate-related disclosure requirements for businesses after a long-awaited period.

Investor activism and engagement are rising, with shareholders increasingly using their voting power to advocate for ESG-related changes within companies. These trends collectively reflect a continued evolution and maturation of the ESG investing landscape in 2024. Other 2024 ESG trends to watch for include:

• Increased integration of artificial intelligence (AI) into ESG risk management, especially for optimizing data-processing tasks around environmental reporting, such as greenhouse gas emission reporting 
• Availability of a more robust database for evidence-based ESG performance measurement and reporting, facilitating informed decision-making and minimizing ESG investing resistance in some jurisdictions 
• ESG investing will remain a politically polarizing issue in the U.S., with an equal potential for pro- and anti-ESG legislation depending on which party emerges victorious in the presidential and congressional elections 
• Biodiversity will become a mainstream ESG topic driven by the current surge in investment funds that focus on biodiversity and nature, as evidenced by the quadrupling of assets under management in Europe for funds dedicated to biodiversity 

Controversies and Criticisms

What is the Dark Side of ESG?

The dark side of ESG includes: 

Potential for greenwashing: Companies may exaggerate or misrepresent their ESG credentials to attract investors, leading to misleading information and ineffective sustainability initiatives.

Limited standardization across ESG funds: Lack of uniformity in ESG metrics and reporting standards can make it difficult for investors to accurately assess companies' sustainability performance.

Exclusionary practices: ESG screening criteria may lead to the exclusion of entire regions, industries or sectors from investment portfolios without effectively addressing underlying sustainability challenges, raising concerns about unintended consequences and ethical implications. For example, an ESG fund that excludes oil won't perform if oil stock goes up.

Potential regulatory risk: Evolving regulations and disclosure requirements related to ESG investing pose compliance challenges for companies and investors. This will exacerbate as the market matures because that will also entail more clearly defined ESG laws and regulations.

High cost of investing: ESG funds track their respective indexes, which are actively managed. Deciding which company gets included requires firms to spend money on additional market research and diligence, which can increase the cost of investing. Research also indicates that active funds underperform passive index funds post-expenses.

Lack of diversification: ESG can lead to less diversification. Many ESG-related funds crashed in 2022, with just 27% outperforming their non-ESG counterparts. The crash occurred primarily for the same reason the funds did great earlier: They're heavily invested in technology companies that had a stellar run and then tanked. Without diversification, your portfolio might be overly exposed to short-term market swings. 

Why People Don’t Like ESG

Retail investors may have various reasons for not liking ESG investing. Some may perceive it as limiting investment options or leading to lower returns. Others may question the authenticity of ESG claims or feel overwhelmed by the complexity of ESG metrics and criteria. 

Some investors also may prioritize financial returns over environmental, social and governance considerations, especially during economic downturns, leading them to prefer traditional investment approaches. Most investors remain unconvinced that a high ESG score leads to better performance. 

Market Perspective

How Big is the ESG Investing Market?

ESG investing has an outsized market and influence, thanks to the trillions of dollars that have poured into sustainable and responsible investment strategies worldwide in recent years. Although enthusiasm for ESG investments grew before COVID-19, the pandemic notably intensified the trend. Market disruptions and uncertainty led investors to turn to ESG funds for increased resilience.

The first quarter of 2020 witnessed an influx of $45.6 billion into such funds globally. This trend continued through 2021 with an inflow of $180 billion in the first quarter before losing steam, with the first quarter of 2022 and the first quarter of 2023 recording $38 billion and $29 billion, respectively. Sustainable investment funds worldwide hold over $30 trillion, with projections suggesting this figure could surge to $40 trillion in 2030 and approximately $50 trillion over the next two decades. If this forecast holds, ESG will account for over 25% of $140 trillion assets under management (AUM). 

Where Is ESG Investing Most Popular??

ESG investing is particularly popular in regions with robust regulatory frameworks and a strong culture of corporate responsibility, such as Western Europe and North America. Countries like the Netherlands, Sweden and Denmark lead the charge in Europe, where most ESG fund assets are concentrated. The United States and Canada are also seeing significant growth in ESG investment. 

Additionally, emerging Asian markets, particularly in countries like Japan and South Korea, increasingly adopt ESG principles in their investment strategies, driven by regulatory changes, investor demand and growing awareness of sustainability issues. PwC projects ESG AUM to hit $3.3 trillion in these Asian-Pacific regions. Africa, the Middle East and Latin America are also gaining momentum, with ESG products accounting for $25 billion in AUM. 

Despite the U.S. ranking second to Europe in ESG fund assets, there's widespread skepticism about the effectiveness of ESG investment strategies. A survey by the Capital Group found that 61% of investors in North America believe asset managers primarily use ESG as a marketing tool to boost sales and reputation, up from 57% in 2021.

How Big is ESG Investing in the US?

The U.S. accounts for 13% of ESG fund assets. Although substantially lower than Europe's 81%, the U.S. has a sizable ESG investing market compared to other regions. This is despite the ESG strategy losing momentum amid political backlash, high interest rates, inflation and greenwashing. 

U.S. ESG investment funds possibly hold about $8 trillion in total assets under management. It peaked in 2020, reaching over $17 trillion, but declined to $8.4 trillion in 2022. Bloomberg BI projects a further 1.5% decline in the compound annual growth rate (CAGR), leading to $9.5 trillion AUM and a global share under 25% (against Europe's 45%) by 2030. This forecast factors in the upcoming election, ESG backlash and high fund market concentration, which can all potentially limit growth.

Do ESG Stocks Outperform the Market?

ESG stocks showed mixed performance relative to the broader equity market. While some studies suggest that ESG-focused companies may outperform the market, others indicate no significant difference. For instance, a study by Morningstar found that over 10 years, more than 70% of sustainable U.S. large-cap equity funds outperform traditional funds. Similarly, Morningstar sustainability indexes with five-year performance histories outperformed their equivalents. 

It makes sense to argue that ESG funds will outperform the broader market in the long term, possibly because of improved risk management and stakeholder trust. But that's not to say that short-term fluctuations and market conditions cannot influence performance differently. Multiple factors should always be considered, and thorough market research must be conducted before investing in ESG stocks. The correlation between ESG factors and stock performance typically varies depending on time horizon, sector and regional factors. 

What Investment Firms Do Not Use ESG?

Amid the political backlash surrounding ESG, some investment firms have started offering anti-ESG funds as an alternative to ESG investing. These firms do not prioritize or incorporate ESG factors into their investment strategies; instead, they focus strictly on financial metrics. More than two dozen anti-ESG funds have been identified, according to Morningstar. The top five anti-ESG funds by assets under management include: 

• Strive US Energy ETF (NYSE: DRLL): $369.2 million
• Inspire 100 ETF (NYSEARCA: BIBL): $294.5 million
• Strive 500 ETF (NYSE: STRV): $266 million
• Inspire Corporate Bond ETF (NYSEARCA: IBD): $256 million
• Inspire International ETF (NYSEARCA: WWJD): $193 million

Almost all of these exchange-traded funds (ETFs) were founded by conservative or rightwing moguls. For instance, Strive Asset Management, the largest anti-ESG ETF provider, was cofounded by failed Republican presidential candidate Vivek Ramaswamy. 

Which Companies Have the Greatest Increase in ESG?

There's no authoritative ESG ranking. However, companies like Sustainalytics play a significant role in assessing and rating companies based on ESG criteria. Because no universal ESG standards exist, you must understand how funds and third-party sources screen companies.

Typically, companies with a high ESG score prioritize their impact on the planet, stakeholders and the environment, aligning their operations with sustainable practices and responsible governance. The table below shows the top 10 companies with the highest ESG scores in 2023, including their ranks.

ESG Reshaping Global Investment Landscape

ESG investing seems poised to reshape the global investment landscape. Integrating sustainability and ethical considerations into investment decisions fosters positive societal and environmental outcomes. 

Beyond financial returns, ESG promotes long-term value creation, mitigating risks associated with environmental and social issues. Investors and businesses recognize its potential to drive positive change while delivering competitive financial performance. However, as the ESG investment industry matures, its resilience will be tested, particularly as enthusiasm resulting from political backlashes and the global economic downturn cools.

Frequently Asked Questions