Sustainable investing has come in for a great deal of criticism since the turn of the year. The fall from grace has been spectacular with several factors contributing such as the revelation that some ESG-labelled funds invested in companies with significant exposure to Russia1, the challenge of balancing the need for energy security and affordable prices with the green energy transition and the debate over the role of defence companies in sustainability focussed portfolios.
As a relatively new field, sustainable investing suffers from a lack of commonly agreed standards and metrics as to what represents best practice, meaning that to some extent, the ESG profile of a company is at least partly in the eye of the beholder.
This has some important consequences. For example, it makes it difficult to group ESG funds together when analysing performance - as a group they have quite different holdings from one fund to the next, which brings with it different risk profiles and sensitivities. To talk about the performance of ESG funds as a single group is a large over-simplification.
It also risks undermining confidence in the integrity of sustainability analysis, which I believe is an unfounded concern. For example, much has been made of the lack of correlation between the ESG ratings of a given stock from the major 3rd party rating agencies2 (such as MSCI and Morningstar) when compared to the very tight correlation of bond ratings for a given issuer. However, much of the difference is explained by different methodologies used and a fundamental difference in what the agencies are trying to measure (for example measuring the risk to a company’s valuation from ESG factors versus the impact a company has on environmental and social factors). This is why detailed stock-level analysis is vitally important, a key reason why we rely heavily on the Fidelity proprietary ESG score in our stock research and selection process.
I think this debate risks missing the wood for the trees. No - we do not have perfect universally agreed upon framework to score companies on sustainability. However, neither is there universal agreement by the market on whether a certain stock is a buy or a sell. Aspects of sustainability will mean different things to different people, and that is ok; I believe we need to accept there is a level of subjectivity involved.
Perhaps most importantly, we mustn’t let this plurality of approaches impede the pursuit of further progress. Just because there is no standardised sustainable investing framework does not mean that we should abandon the approach all together, as some critics would argue3. To say that investors should stop pressuring companies to introduce or improve important goals such as emissions reductions targets, supply chain auditing or access to employee training and talent development programs until a common framework emerges seems misplaced. Investors, alongside governments and regulators, should be encouraging constant improvement at the companies we engage with whilst the sustainable investing industry continues to develop and mature, as there is little time to lose in tackling many of the biggest challenges facing society.
Navigating a changing investing landscape
One challenge the industry has been navigating in 2022 is the ongoing shifts in the broader investment landscape. Global interest rates have been falling steadily for the past 4 decades, driving lower discount rates and higher valuations for stocks, and in particular, quality growth stocks. This has undoubtedly favoured the sustainable investing trend, given an ESG lens naturally tends to bias toward quality companies with strong long-term growth potential. Therefore, the shift to higher interest rates, inflation and energy prices have all presented challenges this year.