Understanding the recent rise of sustainable investing
Sustainable investing has been growing in popularity for over a decade, with total ESG assets projected to reach $50 trillion—or one third of global AUM—by 2025. According to a 2021 Deloitte Global Millennial Survey, factors such as the COVID-19 pandemic, extreme climate events, and a charged sociopolitical atmosphere may have reinforced the need for corporate accountability and a focus on certain environmental, social, and governance (ESG) issues for both for investors and companies alike.
This chart is a measurement of total assets invested in ESG Incorporation, Overlapping Strategies, and Shareholder Advocacy, measured in billions from 1995 to 2022. The total assets increase exponentially over time.
According to the US SIF, “ESG Incorporation” represents strategies that integrated environmental, social, or corporate governance factors into portfolio analysis. “Shareholder Advocacy” represents institutional investors or asset managers that filed shareholder resolutions pertaining to ESG issues. “Overlapping Strategies” included some elements of both ESG Incorporation and Shareholder Advocacy.
As more investors adopt sustainable strategies, their reasoning often boils down to three main motivations or objectives:
- Alignment with personal values
- Portfolio performance and risk management
- The opportunity to help make a difference
Understanding each of these motivations can help us unpack sustainable investing’s trajectory from niche approach to mainstream status.
1. Bringing personal principles to the forefront through values-based investing
Investors with this motivation want to match their investments with their personal values and beliefs to feel good about where their money is invested.
Values-based investing is a strategy under the sustainable investing umbrella that first appeared centuries ago, championed by religious and activist communities who wanted to divest from certain industries, such as alcohol, tobacco, or weapons. Beginning in the 18th century, for example, American Quakers refused to finance the slave trade.
Other religious denominations followed suit by prioritizing their values-aligned investment decisions, often over financial returns. This initial form of values-based investing—also called socially responsible investing—remained primarily a faith-based approach until the 1960s and ‘70s, when labor unions and civil rights activists started using assets as a lever for social change. Popular movements include divesting from companies that supported the South African government during Apartheid and the launch of the Pax World Fund in 1971, which provided an alternative for those wanting to divest from Agent Orange supply chains.
Values-based investment approaches remained relatively niche until the release of the 2004 UN Global Compact report. The report outlined a vital framework that demonstrated how investors could prioritize environmental, social, and governance factors alongside their portfolio’s financial returns, as well as guidelines to help them determine which companies could potentially reflect positive investing goals.
Now that values-based investing strategies have become commonplace, investors are fortunate to have more robust options and well-developed tools that can help them achieve a values-aligned portfolio that does not necessarily sacrifice financial performance. The concept of values-based investing has evolved—it’s no longer just about limiting exposure to harmful sectors. Today, investors can avoid companies that do not match their values as well as actively lean into companies that do.
2. Prioritizing financial performance while mitigating risk
Investors with this motivation want to use ESG criteria to optimize their portfolios and improve their long-term investment results.
Beyond just a desire to “do good,” investors have realized that actively considering ESG factors can result in better risk-adjusted returns over time. In a recent J.P. Morgan survey, more than half of ultra-high net worth investors across all regions prioritized investments that seek to make an impact on ESG factors while also producing a strong rate of return.
We’ve also seen more evidence that suggests a positive relationship between ESG factors and financial performance. For example, as discussed in the J.P. Morgan article “How Smart ESG Investing Could Boost Portfolio Returns,” companies with higher ESG ratings can potentially be more profitable than those with lower ESG ratings over the long term.
Sustainable investing encourages industry leaders to continuously mitigate potential reputational risk and volatility. Today, 96% percent of S&P 500 companies now publish ESG reports in some form, which is a 43% increase over the past decade. These companies may also be better prepared for regulatory changes, such as the European Union’s Sustainable Finance Disclosure Regulation (SFDR) and potential guidelines for environmental disclosures by the U.S. Security and Exchange Commission.
On the other side of the spectrum, recent societal changes and global events have further exposed companies that aren’t prioritizing their workers, supply chains, or customers. This lack of action poses possible threats to their long-term profitability.
ESG analysis acts as another tool in the investment management toolbox by helping to expose possible risks and opportunities within a portfolio. This can be motivation enough for many investors to adopt sustainable investing strategies.
3. The opportunity to effect change with impact investing
Investors with this motivation want to do their part to make a positive impact on the world through their investment dollars.
Also known as impact investing, this form of sustainable investing seeks to move the dial on environmental and/or social progress. For many investors, it’s not just about personal values alignment or financial returns, but about driving towards specific outcomes with their investment portfolios.
Increasing discourse on racial and gender inequality, wealth disparity, and an escalating climate crisis has compelled many investors to try to spark change in a variety of ways, including through their investment portfolios. According to the 2021 Kiplinger Public Opinion Poll, 52% of investors are more likely to invest in sustainable and impact funds because of news related to climate change, 35% because of social unrest, and 32% because of the pandemic.
These numbers are even higher for millennials and Gen Z, who are well-known for sharing their opinions online, questioning institutions, and taking a stand against issues like income inequality or systemic racism. New studies report that 62% of millennials believe that they can achieve more long-term positive change through impact investing as opposed to charitable giving, and they’re more active impact investors than older demographics.
Impact investing strategies could continue to mainstream, possibly thanks to increased momentum from younger generations. Recent estimates by the Global Impact Investing Network (GIIN) found that impact investing has attracted $1.1 trillion dollars AUM globally—and 40% of investors plan on making their first impact investments in the coming year.
Harnessing the momentum behind sustainable investing
No matter the motivation, sustainable investing creates unique opportunities for a broad range of investors. But many people still aren’t aware that investing according to their values—whether for personal, financial, or societal gain—is even possible or profitable.
As sustainable investing options—including values-based investing—continue expanding across asset classes, both advisors and investors can take advantage of a growing number of resources that answer frequently asked questions, break down ESG data, and deliver lasting value.