Insights into Sustainable Investment
What is Sustainable/ESG Investing?
The concept of directing investment funds towards businesses or causes that incorporate a degree of altruism within their ethos has a long history. In 1928, the US Pioneer Fund was launched which provided ‘responsible investors’ an opportunity to exclude alcohol and tobacco companies from their portfolios. In recent times, the term ESG, which stands for Environmental, Social and Governance, has been broadly accepted as the way to measure and incorporate sustainable practices in conjunction with risk and return in the investment selection process. ESG factors are wide-ranging and focus on the non-financial metrics of a business or investment to evaluate their impact on the natural world and society. Some of the factors included in ESG analysis are:
ESG | ||
Environmental | Social | Governance |
Climate change strategy | Labor practices | Executive pay |
Natural resource use | Community impact | Compliance and ethics |
Energy efficiency | Workplace conditions | Political lobbying |
Waste management | Employee engagement | Board composition |
Other concepts or approaches associated with professional ESG investing include:
- ESG Integration – Environmental, social and governance factors are included as central components in the due diligence process to improve the risk/return profile of a portfolio.
- Impact Investing – For investors that seek to make a positive social or environmental impact by allocating funds to select companies or opportunities.
- Positive/Negative Screening – Uses ESG factors to align investment choices to the values of an investor. Specific companies or sectors are included or excluded from a portfolio based upon their source of revenue. Excluding companies that generate revenue from alcohol or tobacco is an example of negative screening.
Why Does ESG Investing Matter?
During the 21st century, there has been abundant evidence that points towards the ever-increasing desire of both individual and institutional investors to incorporate ESG factors in their investment choices. In 2006, the UN launched its Principles for Responsible Investment Initiative to promote sustainable investment practices. Signatories of the initiative are required to adhere to ESG based principles in a fiduciary capacity. As of December 2024, the number of signatories exceeded 5,000 with $128 trillion in assets under management, which accounts for more than half of the world's institutional investments. In 2018 the CEO of Blackrock, Larry Fink, wrote in his letter to other CEOs that ‘Society is demanding that companies, both public and private, serve a social purpose. To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society.’ Indeed, this is a clear message from the person that presides over a business with over $11 trillion in assets under management. In 2018, a Responsible Investing Survey by RBC found that ‘72% of respondents either somewhat or significantly use ESG principles as part of their investment approach and decision making.’ The takeaway from these examples is that ESG investing not only matters, but it is already widely adopted by professionals around the world.
ESG Performance
Including ESG factors into the investment decision making process allows investors to better align their choices with their values. However, that alone would be unlikely to satisfy investors over the long term if the performance of ESG-based investments were not comparable or superior to that of the overall market. The graphic below is from our investment team and it illustrates the average annual return over the past 10 years of several ESG-themed mutual funds and ETFS alongside the S&P 500. Collectively, the 5 funds hold approximately $28.6 billion in assets at the time of writing and that is likely to increase. All but one of the funds outperformed to S&P 500 with 2 of them (BAFWX, NVLIX) doing so by a considerable margin.
A 2022 article published in Barron’s quoted the director of environmental research and engagement at Alliance Bernstein, Sara Rosner:
“a growing recognition that ESG risks and opportunities are fundamental financial risks and opportunities, and that incorporating ESG research and analysis into our process actually makes us better investors”
Her comments align with the performance evident in the ESG funds herein.
ESG Investment Trends
From 2018 to 2024 the value of global ESG fund assets increased from approximately $600 billion to more than $3.2 trillion according to Morningstar Sustainalytics. While the growth is impressive, it is worth noting that US investors account for only $353bn of the total ESG fund market with the lion’s share belonging to European funds as illustrated below:
Source: Morningstar
ESG-based investing in Europe should continue to gain traction, but there are also significant headwinds to overcome in 2025 and beyond. Regulators within the European Union are expected to release the results of several sustainability initiatives that have placed additional costs and complexity on businesses and asset managers. The value of such policies will come under increased scrutiny by business leaders and politicians in the time ahead.
In contrast to Europe, the popularity of ESG funds within the US is currently on a downward trajectory. Almost $32 billion in assets flowed out of sustainable US funds over the last 2 years along with a record 71 fund closures in 2024.
Another issue that needs to be rectified by the ESG investment community is related to the divergence of sustainability scores by professional ratings agencies. A 2022 academic study found a 0.54 correlation in ESG company ratings between the top several rating agencies. For context, credit rating agencies like Moody’s and Standard & Poor’s share a 0.92 correlation score. As a result, investors find it difficult to make appropriate choices when relying on ratings scores as tool. Sustainability ratings have a crucial role to play, but firms will need to improve transparency and collaboration. If not, it could end up being a task for regulators, which is not ideal.
Despite differences in economics or politics between countries, the future of sustainable investing will likely be driven by investors. Public interest in aligning their values with their investment choices, coupled with competitive performance, should bode well for the continued uptake of ESG-themed investing. At Wolf Group Capital Advisors, we offer a variety of solutions that allow our clients to tailor portfolios to match their convictions and performance expectations, while concurrently managing risk.
Sincerely,
Financial Advisor
About Wolf Group Capital Advisors
At Wolf Group Capital Advisors, a comprehensive wealth management firm and Registered Investment Advisor (RIA) based in the Washington, D.C. metropolitan area, nothing is more important than the fiduciary responsibility we have in managing your wealth. Taking the utmost care, we focus on providing advice tailored to your specific circumstances. With more than two decades advising U.S. expatriates and non-US citizens employed by international organizations, we are qualified in investment strategies addressing global issues. Empathy and curiosity—combined with our experience in life planning and investment management—enable you to explore a wider set of possibilities that can lead to a fulfilling life you’ve worked hard to attain.
Disclosure:
The views expressed represent the opinions of Wolf Group Capital Advisors as of the date noted and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person. The information contained has been compiled from sources deemed reliable, yet accuracy is not guaranteed.
Diversification and asset allocation do not ensure a profit or guarantee against loss.
The information presented is not an offer or a solicitation to buy or sell securities. The information contained in this presentation has been compiled from third-party sources and is believed to be reliable; however, its accuracy is not guaranteed and should not be relied upon in any way whatsoever. This presentation may not be construed as investment, tax or legal advice and does not give investment recommendations. Any opinion included in this report constitutes our judgment as of the date of this report and is subject to change without notice.
Additional information, including management fees and expenses, is provided on our Form ADV Part 2 available upon request or at the SEC’s Investment Adviser Public Disclosure website. Past performance is not a guarantee of future results.