“Sustainable Investing” is shrinking

Sustainable investing is shrinking, according to a major new study. Market turmoil, the backlash against ESG and new regulations mean that fewer assets are being described as "sustainable". But this is all good news. Why? Because with a history of woolly definitions, fluffy frameworks and some outrageous greenwashing, it's actually a great sign that the industry is finally starting to grow up.

First, the facts from a new report from the Global Sustainable Investment Alliance (GSIA). The global picture is one of contraction. A $35 trillion industry in 2020 has shrunk to $30 trillion in 2022 – a 14% fall in absolute terms. But when we look at sustainable/ESG assets as a proportion of the total market, the decline is even more dramatic. Whilst one dollar in every three was invested under an ESG or sustainable mandate in 2020, today it’s fallen to one in four.

Is this just due to the US backlash? Let's strip out the figures for America. True, the total value of sustainable assets in major markets ex-US has grown by a healthy 20% since 2020. It's now a $22 trillion market, up from $18 trillion. That's a strong performance. But as a proportion of all monies invested, ESG and sustainable mandates have flatlined. In other words, even beyond America, the wider market has grown faster. Although the numbers aren't in the report, I’ve been able to recalculate figures to strip out the US for comparison with 2020. This shows that sustainable/ESG assets as a proportion of total investments shrunk ever so slightly from 39.1% in 2020 to 37.9% in 2022. So this is not a story limited to the US.

Regional trends in Fig 4: Global Sustainable Investment Review 2022

There are some fascinating regional trends. The market is booming in Japan, Australia and New Zealand. Yet Europe, Canada and the US have all seen falls in proportion to the wider market. In Europe, this is a long-term decline from an extraordinary 59% of assets in 2014 to 38% by 2022. Yet the falls in the US are by far the sharpest.  One in every three dollars was described as ESG/sustainable before, but a measly 13% were reported in the latest US figures.

What’s going on? It’s clearly been a torrid time in financial markets. Tech stocks (often the ESG darlings) led the boom of the 2010s right up to the pandemic. That came to a screeching halt with Russia’s invasion of Ukraine, surging inflation and rising interest rates. Suddenly, if you weren’t in big oil, commodities or defence, you got left behind.  Themes like renewable energy have taken a hammering as uncertainty over rates lingered. All this led ESG to underperform on most measures in 2022. Given this, in many ways it’s amazing that demand has been sustained. The money has continued to flow in: absolute levels of sustainable investing have grown outside of the US. It is a long-term game. Sustainable investing is here to stay.

But it’s the politics that has been most dramatic. In the US, Republicans have lined up to declare ESG “woke”. “Bans” on ESG mandates in state investments have been introduced.  The mood music has shifted. Larry Fink, poster boy of the movement, claimed earlier this year to have stopped using the term ESG altogether. “Anti-ESG” investments have been launched, like the God Bless America Fund (Ticker: YALL, strapline: “stop investing in woke companies”, promise: “profit before politics”).

Yet it’s how we count ESG and sustainable investing that matters most. Changes to the methodology explain most of the shifts in today's report. Last time, any investor with a firm-wide ESG mandate had all their assets counted in the US, alongside any fund describing itself as “ESG” or “sustainable”. That led to some jaw dropping numbers in 2020. Now, only funds that explicitly reference ESG integration as part of their decision-making and portfolio construction (in the prospectus) were included. Asset managers were also asked to provide actual evidence of what specific criteria were used for screening. That's a much tighter scope. As the US is the largest market, it's created a massive impact on the numbers.

In other words, the bar was raised. The definitions got stricter. As new regulations around fund labelling come into force, asset managers are becoming much more cautious. Risk aversion has returned. “Greenhushing” has emerged as a trend where investors and companies play down their activities for fear of being tripped up.

Adapted from GSIA Review 2022 Figure 6

Finally, there's good news in terms of investor strategies. Whilst screening and ESG integration remain widespread, “corporate engagement and shareholder action” has become the most popular approach. That’s a very positive trend because, as my forthcoming book explores, active engagement has a much stronger claim to real-world impact that tweaking, tilting and screening portfolios.

All this means that we should rejoice. The industry is growing up.  GSIA has been working with Principles for Responsible Investment and CFA Institute on tighter frameworks and definitions.  Regulation is propelling the caution. With greater prescriptions over what should and can be labelled ESG or sustainable, the risks of greenwashing, the brazen overclaiming, will reduce. So it's no surprise that ESG appears to be shrinking. We are now counting it more rigorously.

ESG investing has survived the market turmoil. It will thrive into the future. If the industry is becoming more cautious in labelling sustainable investments, that is something to celebrate.