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The UK finally cut interest rates to 5% yesterday. I thought this was the right decision. Today’s major risk does not look to be inflation to me but growth. Continuing to throttle the construction and real estate sectors to lower inflation that is – to my eyes – near enough to the Bank of England’s long term target just feels unnecessarily cruel. Market pricing this morning suggests a Bank Base Rate of around 4% in 12 months’ time and maybe a low of 3%-3.5% in UK rates for this cycle. The US is expected to follow suit in September.
My colleague, Tiziana Maida, heads up our environmental, social, and governance (ESG) focussed investments at IPS. She is starting a monthly client note (similar in approach and length to this one) this month. If you want to be included on the distribution list, please do get in touch. In light of this – and with the disclaimer that Tiziana is the actual expert here – I thought I would take the opportunity to offer the views of a middle aged white man on the subject. Surely there is room for more of this sort of thing? But in my defence, this would be the high level take of an asset allocator who could (and indeed has) invested in ESG assets rather than a domain expert like Tiziana.
In this light, the questions that interest me are:
- How has ESG performance been relative to unconstrained portfolios? What is the outlook for the next few years?
- Has ESG investing had much of an actual impact? And how much is hot air or – in the jargon – greenwashing?
- How is the political environment for ESG investing changing in the US and Europe?
Performance
On performance, the simple story is that ESG investing had a very good run until 2021 and since then it has struggled (relative to unconstrained portfolios at least). Longer term ESG investors should, I think, be pretty happy with their outcome. Those who invested more recently (from 2021 onwards) will have likely under-performed a more traditional approach.
What is going on here? ESG investing is a version of thematic investing. And in the early days of ESG the theme was working. This attracted more investors to the story, more money flowed to ESG focussed assets, prices and premiums rose for them and the out-performance continued.
It took the post-Covid inflation surge and, in particular, the Ukraine war to burst this bubble. With any thematic investment, it is what you don’t own that often hurts you. ESG investors deliberately did not own the fossil fuel and mining companies that benefitted hugely from Russian sanctions in 2022. Some do not own many semiconductor companies (like Nvidia) which are earning large AI investment driven profits. This has driven their recent (relative) under-performance but is also a pretty standard feature of any thematic approach. I would expect unconstrained portfolios to out-perform constrained ones over long time horizons. And, looking forward, I’d expect continued variability for ESG investors compared to more traditional approaches. The good news is that today’s starting point is a much better one for ESG investors than the heady and bubbly days of 2021. We may even be due some catch-up outperformance.
Has ESG investing had much of an impact?
Here I think the answer is yes. All companies want to attract the widest pool of investors and many (most?) are changing how they run their business to attract ESG money. There is some cynicism in the market about all this but I think the impact of ESG investing is very real. Have a look at the annual reports of BP or Shell if you don’t believe me. Or you can talk to commodity experts who will tell you of under-investment in many commodity sectors as much new energy investment is renewable and environmentally focussed (even though you need plenty of commodities to make renewables work of course). If your concern is: is my ESG focussed investment having an impact, I think the answer is pretty clearly yes.
How is the political environment for ESG investing changing?
But because the impact is real politicians are, understandably, increasingly getting involved. In the US, it feels to me that today the ESG agenda = Democrats. This is starting to place real limits on what companies can do as being more vocal on ESG issues will, inevitably, please half of your US investor base but annoy much of the rest. As an example, Microsoft, a previously high scoring ESG company, just scrapped its Diversity Equity and Inclusion (DEI) team. The previous successes of ESG pressure are leading to a political backlash. You would expect, of course, this to continue under Trump but I think ESG investing is here to stay. That said, the tug of war between left and right on this issue looks to be a core part of US politics for the next generation.
In Europe, ESG issues still seem more consensual. Right wing parties (like Reform in the UK) have taken an approach similar to the Republicans in the US but the main centre right and centre left European parties still seem to be in harmony with the main objectives of ESG investors. Tiziana has more detail on recent ESG political changes in the US and Europe in her monthly notes. Overall, I would say that in spite of the backlash, general political support for the ESG agenda is still very much there. After a tougher run of performance, the outlook may be brightening once again.
Chris Brown, CIO
cbrown@ipscap.com
The value of investments may fall as well as rise and you may not get back all capital invested. Past Performance is not a guide to future performance and should not be relied upon. Nothing in this market commentary should be read as or constitutes investment advice.
