The fast-paced evolution of the 21st century has brought rapid advances in technology, exponential increases in the global scale of production and increased comfort and wealth for the majority of our planet. However alongside this, environmental destruction is also at its all time high. Global warming, pollution and unpredictable natural disasters leave billions of people more vulnerable than ever before. Impact investing is undoubtedly a step in the right direction, fulfilling the need of generating financial returns for investors while creating a positive environmental or social impact. Impact investing can be done in a large variety of ways, from investing in developing projects to increasing the supply of affordable housing, to investing in renewable energy firms, the list goes on..
ESG funds are investment portfolios that include stocks and/or bonds, and they incorporate environmental, social, and governance considerations into their investment strategy.
Investors pulled £8 billion out of ESG funds in 2023, marking the first year of net outflows since the funds' inception. While the ESG market boomed from 2020 to 2022, with investors pouring in six times more money than they did in funds without specific ESG commitments, there are concerns that the market is now facing a correction. 2022 also witnessed the ESG market take a hit, with U.S. inflows dropping to $3.1 billion. While headwinds like inflation and rising interest rates played a role, self-inflicted wounds also contributed. BlackRock, once the leading force, saw its sustainable fund inflows plummet, possibly due to controversies such as the politicization of the term ESG. CEO Larry Fink explained that he doesn’t, "use the word ESG any more, because it's been entirely weaponised ... by the far left and weaponised by the far right." Passively managed funds took the spotlight as investors displayed more caution in actively managed funds. Additionally, rising interest rates led to fixed-income instruments such as bonds returning more than stocks, further driving investors away from actively managed funds.
Evaluating an ESG fund's impact and alignment can be complex. MSCI, a leading ESG research provider, has developed several key metrics to provide more accurate information to investors who are looking to use their capital sustainably. 4 key statistics MSCI utilises are:
1) MSCI ESG Fund Rating: This letter grade (CCC-AAA) assesses the overall ESG risk profile of the entire fund. It considers how well the fund manages ESG risks compared to its peers, taking into account the individual ESG ratings of each holding and their weightings within the fund. A high rating (AAA, AA) indicates strong management of ESG risks, while a low rating (B, CCC) suggests potential concerns.
2) MSCI ESG Quality Score: This score (0-10) focuses specifically on the quality of the research and data underlying the fund's ESG integration practices. A higher score reflects a more robust approach, with strong data coverage, clear integration into investment decisions, and active engagement with companies on ESG issues. This metric helps assess the transparency and credibility of the fund's ESG claims.
3) MSCI Weighted Average Carbon Intensity: This metric measures the average greenhouse gas emissions per million dollars of revenue generated by the companies held by the fund. This is essentially a weighted average of each company's carbon footprint, reflecting the fund's overall exposure to carbon emissions. A lower score indicates a more sustainable portfolio with lower climate impact.
4) MSCI Implied Temperature Rise: This metric goes beyond carbon intensity by translating the average emissions of the fund’s portfolio into an estimated global temperature rise scenario. It ranges from 0°C (no warming) to 3.0+°C (significant warming). This metric helps investors understand the potential long-term climate impact of the fund’s investments.
The introduction of ESG funds play a pivotal role in companies that have stronger ESG performances. As investors are drawn to these companies due to mutual values, there will be an increase in finance and capital which results in lower capital costs and a higher valuation.
There are three key trends that are shaping current trends in the ESG fund industry. First, there is a growing focus on impact investing. Second, there is a demand for more transparency and standardisation in ESG reporting, so that investors can better understand how funds are investing their money. Third, there is a rise in activism among investors, who are putting pressure on companies to improve their ESG performance. While there may be some short-term challenges, the long-term outlook for ESG funds is positive, driven by the increasing demand from investors for sustainable and responsible investments.
With the introduction of Impact Investing and ESG funds, the gap between creating individual wealth and staying true to one’s values has never been smaller. Investors are now given an option to not only help their bank account, but also countless people that will benefit from their investments. Companies adapting to this strive to better their ESG impacts, allowing for increased funding and the ability to increase their social and environmental impacts. Undoubtedly, the world is evolving at an increasing rate but the positive impacts of this new sustainable investing strategy shines a bright light on a previously bleak future.
Sources:
https://www.sopact.com/guides/impact-investment-examples#:~:text=Here%20are%20a%20few%20examples,operate%20solar%20or%20wind%20farms.
Authors: Wai Kin and Ayan
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