ESG Outlook: The World Is Still in the Early Innings of an Era of Sustainable Investing
Demand for sustainable investment solutions continues to expand—across borders, asset classes and generations. According to Morningstar, assets in sustainable funds topped $357 billion in 2021, a four-fold increase from three years ago and a 35% increase over 2020’s highs.¹
What will sustain this momentum? Ongoing shifts in consumer preferences and the remarkable speed with which information now spreads are making retail investors increasingly concerned with not just how much money they make in the market, but how they make that money. Institutional investors are also increasingly committed to achieving net-zero targets (e.g., over two-thirds of global emissions are now covered by national net-zero policies), driving changes in allocations and flows into sustainable solutions.²
In 2022, we expect sustainable investing to be propelled by a trifecta of rising demand for investments that incorporate ESG factors, favorable economics, and supportive policies and regulations.
The EU Taxonomy for Sustainable Activities is perhaps the best known of these policies, but the EU is far from the only regime implementing sustainability guidelines. The UN Principles for Responsible Investment notes that “there have been over 730 hard and soft law policy revisions, across some 500 policy instruments, which support, encourage or require investors to consider long-term value drivers, including ESG factors. [Among] top 50 economies, 48 have some form of policy designed to help investors consider sustainability risks, opportunities or outcomes.”³
In 2022, we expect policies and regulations governing sustainable investing to expand, with some of the potentially most impactful unfolding in the United States. The Securities and Exchange Commission is focusing on corporate ESG disclosures, and there is a distinct possibility that retirement plans will be able to incorporate ESG-related considerations into their investing under a proposed U.S. Department of Labor rule.
Key Themes for 2022 and Beyond
In our view, five key themes about how to move toward a sustainable global economy will dominate conversations and approaches to ESG-related investing over the next 12 months and into the future:
Within these themes, our research has identified major trends we believe are likely to be significant hot-button topics in 2022:
Labor, the Ultimate Scarce Resource (Empowerment)
In the second half of 2021, over 20 million U.S. workers left their jobs in a movement popularly known as the Great Resignation. High turnover directly impacts a company’s bottom line.
Although pundits debate the causes of this Big Quit, “burnout” and “flexibility” consistently emerge as reasons for quitting. Because power is shifting to employees in today’s tight labor market, employers should not only rethink their compensation, benefits and career growth opportunities but how the company’s culture demonstrably values the “humanity” aspect of its human resources.
The gig economy, a relatively new factor in the employment picture, is expanding due to an influx of workers who are part of the Great Resignation and hope to achieve greater flexibility in their work lives. This trend will draw even more attention to issues of worker protections, benefits and labor policies. In some cases, the business models of companies that rely on a gig workforce may come under severe pressure if new policies require protections for these workers.
Gallup estimates that decreased engagement during 2020 cost the global economy US$8.1 trillion in lost productivity due to 80% of employees either “not engaged” or “actively disengaged.”⁴
The Food Crisis (Sustainable Living)
Under its Sustainable Development Goals, the United Nations has a target of ending hunger by 2030; however, 9% of the world’s population is severely food insecure and 25% is moderately or severely food insecure.⁵ The food and beverage industry extracts finite resources, harms various ecosystems and is responsible for approximately 37% of global greenhouse gas emissions.⁶
Shifting to a circular food economy would reduce waste and help preserve raw materials, water and energy. A sustainable food system would help eliminate food waste and ensure food availability in developing countries. The transition to a circular economy for food would also involve converting to plant-based diets and increasing regenerative agriculture practices. These changes would likely reduce food industry costs and help make food more affordable and more readily available to consumers in developing countries.
Biodiversity – Climate Change 2.0 (Environment)
The push to reduce carbon emissions has dominated headlines in recent years. While these efforts will deservedly continue to generate much attention, we expect investors to increasingly focus on biodiversity or the variety of living species on earth.
The economic impacts of biodiversity are staggering. World Economic Forum (WEF) research shows that $44 trillion of economic value generation—more than half of the world’s total GDP—is moderately or highly dependent on nature and its services and is therefore exposed to nature loss.⁷
The environmental impacts are just as shocking. According to the OECD, the world has lost 60% of its global vertebrate population since 1970 and more than 40% of insect species are declining rapidly, on par with previous mass extinction events.⁸ The 2022 WEF Global Risks report cites biodiversity loss as one key risk society faces over the next two to five years—clearly, the issue deserves increased attention from investors.
COVID-19 lockdowns and restrictions have changed the way we live and work, increasing our dependence on the internet and digital economy. Remote work and increased cloud-based activities contributed to making 2021 a record year for data breaches. According to IBM, the average cost per incident for 500-plus global organizations grew from $3.86 million to $4.24 million in 2021—the highest cost recorded in 17 years of similar reporting.⁹
Technology will be a significant driver of global growth over the next decade, and cybersecurity is costing companies more than ever. Impacts include the cost of resources devoted to protecting data and systems, the economic and reputational impacts of a breach, and expense of providing training, oversight and enterprise risk assessments to help prevent attacks. This represents a significant opportunity for innovation and investment in crucial areas such as security, protection and cyber risk management that are likely to see exponential growth in the years to come.
We believe many investment opportunities in health care overlap with sustainability goals in the areas of innovation, cost and access. For example, unprecedented corporate innovation, as evidenced by a record number of research publications, citations and new drug approvals has been an enduring theme in the health care sector in recent years.
We have seen many powerful advancements—from COVID vaccines to clinical trials using CRISPR and other gene-editing technologies to prevent or treat malaria, cancer and other diseases. We fully expect 2022 to be another year in which new drugs and medical devices improve health and quality of life worldwide.
Perhaps no topic highlights issues around innovation, cost and access as fully as the COVID-19 pandemic. The rapid development and distribution of safe, effective vaccines clearly validates the importance of health care research and innovation. However, vaccine costs and uneven health care infrastructure across countries have resulted in a staggering disparity in vaccination rates between developed and developing nations, underscoring the need for more equitable distribution of health care services. A single statistic demonstrates the magnitude of this challenge—the World Health Organization estimates that just 11% of Africa’s population is fully vaccinated and 85% have yet to receive a single dose.¹⁰
Actions Speak Louder Than Words
We expect engagement and proxy voting to continue taking center stage in 2022 as investors increasingly demand transparency around stewardship activities. In 2021, an activist investor’s successful campaign to install three board members at ExxonMobil signaled a potential turning point for environmental and social resolutions.
Shareholders are increasing the pressure on companies to disclose political spending, lobbying and trade association activities. In 2021, a record 40% of shareholder proposals seeking disclosure of corporate political activities were adopted, breaking the previous year’s record of 20%.¹¹
Another trend that accelerated in 2021 was a push for disclosure of companies’ funding of climate lobbying, including requests for analyses of a company’s positions on climate change issues compared to those of its industry groups and lobbying partners, such as trade associations.
A 2020 Willis Towers Watson survey found that four in five companies are considering introducing ESG-linked executive pay and similar measures over the next three years to emphasize the importance of improving environmental and social factors in business operations.¹²
Some ESG issues commonly linked to executive pay include setting and making progress toward net-zero and climate targets, measures of human capital, and diversity, equity and inclusion metrics. Regulators globally (especially in the EU) have put forward proposals to accelerate this development through soft and hard laws around integrating ESG factors in executive compensation. ESG-linked pay could improve management accountability and board oversight of companies’ sustainability-related performance.
Where Do We Go From Here?
We expect concerns about greenwashing to continue, with the focus moving beyond just climate issues to all Sustainable Development Goals. While this problem will not be solved easily, the combination of policy proposals in the pipeline that would combat the issue and the investment community’s push for asset managers to report real-world sustainability outcomes with their financial results should provide some clarity and help the industry move toward standardization in 2022 and beyond.
In our view, the most influential change will be a shift in focus away from sustainable investing as just a risk mitigator to an alpha generator. We are calling this concept Alpha Plus, as we believe sustainable and impact strategies have the potential to provide market-beating returns coupled with societal and environmental alpha.
The annual funding gap to achieve the Sustainable Development Goals is $2.5 trillion (and growing due to COVID-19), of which the public capital markets will need to provide $1 trillion to $1.5 trillion—allowing for a significant amount of innovation and growth in the years to come.¹³
Alyssa Stankiewicz, “Sustainable Fund Flows Dip for the Quarter but Peak for the Year,” Morningstar, January 31, 2022.
Richard Black, Kate Cullen and Byron Fay, et al., “Taking Stock: A global assessment of net zero targets,” Energy & Climate Intelligence Unit and Oxford Net Zero,” March 2021.
Principles for Responsible Investment, “Responsible investment regulation map,” September 9, 2019.
Gallup, “State of the Global Workplace 2021 Report,” June 2021.
Max Roser and Hannah Ritchie, “Hunger and Undernourishment,” Our World in Data, 2019.
Krista Charles, “Food production emissions make up more than a third of global total,” New Scientist, September 13, 2021.
World Economic Forum, “Nature Risk Rising: Why the Crisis Engulfing Nature Matters for Business and the Economy,” January 2020.
OECD, “Biodiversity: Finance and the Economic and Business Case for Action,” Report Prepared for the G7 Environment Ministers’ Meeting, May 5-6, 2019.
“IBM Report: Cost of a Data Breach Hits Record High During Pandemic,” IBM Press Release, July 28, 2021.
“Africa needs to ramp up COVID-19 vaccination six-fold,” WHO Africa Press Release, February 3, 2022.
Ki P. Hong, Melissa L. Miles and Karina Bakhshi-Azar, “Companies Face New Pressure from Shareholders and Regulators to Disclose Political Policies and Contributions,” Skadden Insights, January 19, 2022.
Willis Towers Watson, “ESG and Executive Compensation: Hearing from board members globally,” December 9, 2020.
“The challenge: financing the SDG development gap,” Sustainable Development Investment Partnership, accessed February 1, 2022.
When portfolio managers incorporate Environmental, Social and Governance (ESG) factors into an investment strategy, they consider those issues in conjunction with traditional financial analysis. When selecting investments, portfolio managers incorporate ESG factors into the portfolio's existing asset class, time horizon, and objectives. Therefore, ESG factors may limit the investment opportunities available, and the portfolio may perform differently than those that do not incorporate ESG factors. Portfolio managers have ultimate discretion in how ESG issues may impact a portfolio's holdings, and depending on their analysis, investment decisions may not be affected by ESG factors.
Sustainable Development Goals (SDGs) are a collection of 17 global goals set by the United Nations General Assembly. They were developed by a global team of industry and government leaders and adopted by all 193 member states, the SDGs include 17 goals and 169 attendant targets aimed at solving some of the world’s most pressing problems by 2030. The goals include eradicating poverty, providing environmental resources, and achieving gender and income equality.
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