Outlook for sustainable investing

Investment credentials

What shouldn’t get lost in the debate about whether to keep or retire ESG, are the investment credentials of the environmental products industry. They remain strong.

Spending on the green transition hit a record high last year.

The International Energy Agency says that investment in clean energy technologies reached USD2 trillion for the first time in 2024.https://www.iea.org/reports/world-energy-investment-2024

Importantly, most of that capital flowed to cleantech that is proven and commercially viable. Spending on renewables, energy storage, electric vehicles and power grids grew faster than other more novel technologies and accounted for the vast majority of investment.

This shift away from fossil fuels has been gathering momentum for quite some time. The world now spends almost twice as much on clean energy than on oil, gas and coal, with the share of clean sources consistently outpacing that of fossil fuels since 2016, a year after the Paris Agreement was reached. 

Just as importantly, the rise in investment has gone hand in hand with a drop in power generation costs. 

The cost of generating electricity using solar, wind and other alternative sources of energy is decreasing worldwide, in many cases falling below that of traditional fossil fuels.https://www.iea.org/reports/renewables-2024/electricity

These favourable economics should incentivise businesses and governments to invest even more in renewable energy projects.

Of course, that won't be the case in the US, where climate investment has stalled. 

But it will be true in Europe and China, which are both redoubling efforts to develop cleaner and sustainable sources of energy.

In March this year, the UK and China agreed to work closely on climate and clean energy in the first formal talks between the two countries on this matter in nearly eight years, kicking off a new annual dialogue covering issues such as the net zero transition and carbon capture and storage. For its part, the EU is also increasing diplomatic engagement with China as they share net zero as a common goal.

There is money behind the ambition.

According to the IEA, China and the EU have pledged to invest nearly USD800 billion in low-emissions electricity, grids and storage as well as the rest of the clean energy supply chain by the end of the decade to meet their net zero ambitions, with their spending far outweighing that of the US.

Companies that form part of the sustainable equity universe are becoming more investible as a result. 

A study by the London Stock Exchange Group (LSEG) shows market capitalisation of the global green economy – made up of listed companies which provide products and services with environmental benefits which span entire value chains – has grown 15 per cent on a compound annual growth rate basis in 10 years to 2024, the fastest growing sector after technology (see chart).https://www.lseg.com/content/dam/lseg/en_us/documents/sustainability/investing-in-green-economy-2025.pdf

Green equities, the study says, have beaten the benchmark FTSE Global All Cap Index in 70% of all five-year periods. Long-term drivers such as the energy transition and an increase in investment in adaptation and resilience solution are underpinning strong growth of the market, which is now worth almost USD8 trillion, LSEG says. 

Beyond ESG ratings

One positive to emerge from an ESG rethink is a lessening of the influence ESG company ratings have on investment decisions. Ideally, the scores should be used as only one of many inputs into the construction of genuinely sustainable portfolios.

Ratings can be a useful shortcut in some ESG analysis, but the scoring frameworks have serious shortcomings that investment managers can only address using their own models and fundamental analysis. What’s more – and often misunderstood – ESG scores are primarily focused on financial materiality – or environmental or social factors that impact a company’s financial performance.

They reveal little about what is known as impact materiality, or how a company’s activities affect the environment and society, regardless of whether these have financial consequences.Crona, B. (2023) https://doi.org/10.1007/978-981-19-4460-4_6

There are many alternatives to ESG ratings that better capture environmental impact. And if they gain traction in the wake of ESG's demise, that would be a positive outcome. 

Science-based frameworks such as the Planetary Boundaries or Life Cycle Assessment (LCA), for example, allow investors to produce a more comprehensive picture of the impact of company’s activities on multiple environmental dimensions.https://am.pictet.com/ch/en/investment-research/planetary-boundaries-and-environmental-footprint-of-businesses

Models that incorporate the biodiversity impact of a company or industry across its global supply chain are also useful in identifying how businesses both affect the natural world and depend on it for their success.Kulionis, V. https://onlinelibrary.wiley.com/doi/10.1111/jiec.13515

Achieving systemic impact

Another way in which investors with sustainable goals can have a direct positive impact on the environment is by investing in companies whose products and services are central to the green transition.

Take the example of a specialist company that manufactures advanced energy management and automation products. These devices optimise energy and operational efficiency and enhance resilience of infrastructure such as commercial buildings and data centres. Such products have the potential to address critical challenges related to resource scarcity and environmental impact across a broad range of industries, from technology, consumer staples and real estate.

In other words, sustainable investing involves allocating capital to companies whose influence reaches beyond their own operations, helping others reduce their footprint. This is in contrast to mainstream "best in class" environmental strategies, which select companies almost exclusively on the sustainability of their operations rather than the impact of their products and services.

Value creation through engagement

But sustainable investment isn’t only about directing capital to companies that are already green. Investors can also have a positive impact on those which are still in the early stage of transformation by taking a more active approach. 

And here is where a reappraisal of ESG could be an additional help. It could foster the broader adoption of corporate engagement.

Active engagement is effective in bringing about meaningful and positive corporate transformations and can also lead to improved financial returns.

Investors can, for example, encourage the companies they invest in to reduce their carbon footprint by setting to science-based targets and linking them to executive compensation or increase their disclosure on environmental impacts.

Engagement on governance dimensions, such as labour standards, health and safety or the functioning and composition of the company board, can also help mitigate risks and create value.

Where relevant, investors can use proxy voting to reinforce their engagement activity, either by supporting shareholder resolutions or by voting against management when progress is not sufficient.

This approach helps identify future material risks that may not show up in a company’s quarterly results. It can also highlight opportunities among those that show a true commitment to address sustainability challenges -- these companies may offer better opportunities than their peers on the risk mitigation and return spectrum in the years ahead.

All of this helps bring about systemic change by promoting responsible business practices. 

Silver lining

Sustainable investing’s journey to the mainstream adoption
has not been plain sailing. What began as a niche activity, ethical and socially responsible investment has won strong endorsement from institutional investors in particular.

Obstacles to its effectiveness abound, however, including a lack of standardisation, greenwashing and data inconsistency.

But the scrutiny ESG is now attracting in the US and elsewhere has a silver lining. As sustainable investing matures and corrects its course, it is sure to become even more established among long-term investors.