Market turbulence was a defining feature of 2022 and punch-drunk investors, reeling from a combination of market sell-offs and the cost of living crisis, responded by withdrawing record sums from their investments.
In September, the Investment Association registered the eighth consecutive month of net outflows from investment funds, with investors cashing in some £7.6bn from funds. Responsible investment funds, however, have been much more resilient and have only experienced one month of negative flows so far this year.
Although they have continued to attract investors over the course of 2022, the performance of many RI funds has been hit this year and the headwinds they have faced have been well-documented.
Many of the world’s largest companies are now working towards net-zero carbon emissions, and pressure is mounting for others to follow.Those areas of the market that performed strongly in 2022, such as oil-producers, are generally excluded from RI portfolios. At the same time, the growth-oriented technology companies, where RI funds may have greater exposure than their peers, have fallen back, having led markets for several years.
Investing is a long-term game, and no investment strategy should be judged on 12 months’ isolated performance. However, there are strong indications that we are at the cusp of a secular shift whereby the way in which a business conducts itself is of equal importance to investors as the profits it generates.
This shift in mindset is likely to tilt whole sectors towards supporting a more sustainable future.
Take carbon emissions as an example. The recent Cop27 conference saw governments around the world reaffirm commitments to combatting climate change. Geopolitics also plays its part: the war in Ukraine has demonstrated the need for energy security with renewable energy being touted as part of the solution to this problem.
Many of the world’s largest companies, meanwhile, are now working towards net-zero carbon emissions, and pressure is mounting for others to follow their lead. Regulators are adding further impetus to this.
To negate any accusations of greenwashing, it is essential that a manager clearly states how their fund sets out to combat climate change.A combination of these factors should mean that future capital flows will favour those sectors and companies that emit less carbon into the atmosphere or help capture it, while polluters are punished.
Over time, this trend should provide a boost to sustainable investment portfolios, which are likely to have a bias towards cleaner companies. However, there is a distinction between benefiting from a secular trend such as this and hardwiring an objective into a fund’s mandate to make a positive impact on the climate.
As with all funds, financial performance is one metric against which impact funds promising to mitigate climate change funds will be measured. Equally important, however, is the measurement of the extent to which they are delivering on that climate-related promise, something which is more difficult to express.
Nonetheless, to be credible and to negate any accusations of greenwashing, it is essential that a manager clearly states how their fund sets out to combat climate change, demonstrate their success in achieving this and where they do not, clearly explain why.
The responsibility of RI funds goes beyond performance in purely financial terms.This should be supported by whatever data is available, presented in a standardised and accessible way, be that in terms of the amount of carbon emissions reduced or the megawatts of clean energy produced.
Climate change funds represent a relatively small proportion of the universe of RI funds through which investors can help build a brighter future for society and the environment.
Many of these will benefit from changing behaviours at both a personal and corporate level that reward practices that do good, avoid doing harm and lead change.
However, the responsibility of RI funds goes beyond performance in purely financial terms. They must evidence their success in improving the environment or nurturing a more just society.
Although this might present challenges, it also creates a tremendous opportunity for RI funds to demonstrate the power for good that they represent.
Anna Mercer is head of 3D research at Square Mile Investment Consulting and Research
