Investors “stay loyal to ESG funds”

The recent spike in fossil fuel stocks following the war in Ukraine could suggest that investors’ long embrace of climate-friendly companies is starting to cool.

But, as far as affluent British private investors are concerned, this is not the case, say wealth managers.

While some clients have reframed their approach to energy investments in light of the crisis and soaring oil, gas and coal prices, most remain committed to the net zero agenda and, more broadly, to companies that account of environmental, social and governance values ​​(ESG) factors.

Wealth managers told FT Money that investors remained committed to sustainability despite “short-term headwinds” against it.

Granted, the big ESG-based funds have been beaten with the tech-heavy Parnassus Core Equity Fund down 23% this year and iShares ESG Aware down 24%.

But, more broadly, global ESG indices are weathering the market turmoil quite well this year: the MSCI Global ESG Focus Index is down 14.7% since the start of 2022, like the MSCI World All-Stock Index.

Ben Palmer, Head of Responsible Investing at Wealth Manager Brooks Macdonald, said: “Over longer periods, we believe that the structural drivers of sustainability trends, both at the political and consumer level, will be significant tailwinds. While there is a lot of uncertainty in the markets about the short-term direction of travel, we haven’t seen any deterioration in longer-term support. »

He adds: “The tragic events in Ukraine have led to a significant rise in oil and gas prices, but they have also prompted an increased commitment from global policymakers to accelerate their development of renewable energy capacity, in the aim of achieving greater energy independence.

Catherine Hampton of Cazenove Capital adds: “The lofty valuations of many sustainable companies have moderated over the past 18 months and we believe the long-term growth prospects and strong momentum of these companies remain attractive, particularly given the the regulatory and political environment as governments take action to combat climate change.

The EU’s response to the current energy security crisis includes a doubling of solar capacity by 2025 and a tripling of green hydrogen, compared to what was planned before the war in Ukraine, she says .

Richard Flax, chief investment officer at Moneyfarm, the online investment adviser, says a downgrade in the valuations of high-growth companies in recent months – for example Microsoft, Tesla and Nvidia – has had a negative impact on some indices ESG.

“However, a responsible investment approach has a long-term and strategic focus and this is clear to most clients, who understand that a six-month period is not enough to affect the structural change that financial markets have experienced in recent years,” he says.

Max Richardson, head of sustainable finance at Investec, the wealth manager, said investors also might not recognize the risk of fossil fuel reserves remaining in the ground if politics and consumer attitudes accelerate to reaching net zero, the policy of reducing greenhouse gas emissions.

Other managers pointed to a diversity of tastes in the market – with a hard core of ESG investors determined to invest in the sector – regardless of the cost.

Morningstar data shows that leading ESG-labeled companies still have above-average price-to-earnings ratios – suggesting that investors expect high growth rates in the future – although not quite as high than before. The MSCI ESG focus index trades on a forward price-to-earnings ratio of 16, about the same as the MSCI World Index.

Nicolas Ziegelasch, at Killik & Co, says: “We believe that ESG investing is primarily driven by investor preferences for investment type rather than valuation basis, and current high valuations do not seem to have any effect. impact on customer flows.

He predicts that more companies will seek to organize under the ESG banner – and the premiums commanded by ESG stocks could fall. He says: “Longer term, the flow of money into the sector will incentivize more companies to properly report ESG metrics and take action to improve their ESG metrics, thereby increasing the investment pool for ESG investors and reducing thus the scarcity premium applied to the ESG. investments. »

Some managers believe that investing sustainably is not just about pumping money into low-carbon companies, because avoiding fossil fuels and less sustainable companies will create other economic and social problems, as well as reduced funding for those in transition.

Guy Foster, Chief Strategist at Brewin Dolphin, says: “Underinvestment in energy without a reliable alternative contributes to an increase in energy poverty.

Karen Ermel, Director of Responsible Investing at Coutts, says, “Just switching from fossil fuel companies to solar farms won’t make the biggest difference for our investors or the planet. To do this would be to ignore companies that need help transitioning to a net zero economy and already have credible plans to do so, even if they are not there yet.

Killik & Co says clients who previously wanted no exposure to fossil fuels are easing this restriction, a trend also seen in the broader market, reflecting a growing acceptance that reduced fossil fuel investment is funding a shift to renewables. for some companies.

The debate has questioned the definition of ESG funds, as managers have different criteria for qualifying funds, with varying degrees of fossil fuel inclusion.

Gemma Woodward, at Quilter Cheviot, says: “For some strategies investing in fossil fuels would not be within their remit, for others it is appropriate to take an engagement rather than a divestment approach. It is not a one size fits all. »

Ryan Hughes, head of investment research at Manchester-based AJ Bell, adds: “Two funds with the same name, such as Sustainable Growth, could invest quite differently and have quite different risk profiles. At the moment, it’s difficult for investors to properly compare ESG funds without really going into detail, which many retail investors won’t want to do.

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