Article: What’s the ESG investment outlook for 2022?

Damian Handzy | January 14, 2022

One of the most noteworthy trends of 2021 was the broad acceptance of environment, social and governance (ESG) investing in the US financial markets as a fiduciary responsibility. 2021 was a record year for ESG, with an estimated $120 billion poured into sustainable investments, more than double the $51 billion of 2020.

What’s next for ESG investing in 2022?

ESG regulation

In 2021, Europe had already taken significant steps to codify climate risk and sustainability goals as fundamental investment risks. These disclosure requirements will likely strengthen in 2022 as investors and companies grapple with ESG’s ambiguous definition.

Keeping an eye on Europe’s progress thus far, the US SEC also intends to bring transparency and credibility to ESG investments. This will likely be the year the SEC begins requiring similar reporting even before rules are finalized. The particular challenge will be understanding the trade-off between ESG considerations and financial returns, and aligning environmental due diligence with fiduciary duties.

Net-zero transition stocks

Awareness of the role of so-called transition stocks will increase. It is important that investors take into account not only high ESG scoring stocks, but also high ESG improving stocks such as those that support the transition to net zero.

ESG momentum is real and continues to get a boost from the pandemic and climate-friendly federal investments. Investors stand to gain returns from transition stocks as well as helping to make a positive ESG impact.

The interest rate impact on ESG

With the Bank of England’s first rate rise at the end of 2021 along with other countries taking the same path to fighting inflation, we’re looking ahead to further increases in 2022. Rising interest rates will suppress all stock valuations which will impact growth, high volatility, and smaller cap stocks in particular.

We will see the continued flight to quality stocks with value, large cap and low volatility also set to improve. The ongoing pandemic and the rise of new variants like Omicron will drive investors in the same direction. The market headwinds are all pointing toward the same defensiveness.

Navigating climate funds

Climate funds are not all created equal. We came to that conclusion in our recent report on European Climate Funds 2021 which profiles several funds and an ETF to assess investors’ exposures.

What we found is that climate funds are quite distinct from each other in terms of how well they score on ESG, the types of fundamental factor exposures they provide, the industries they invest in, and the degree to which they correlate with one another.

The disparities in investment practices in climate funds has widened significantly between 2020 and 2021, and those gaps are only going to get bigger. As more money flows in and funds work to differentiate themselves, the range of investment approaches will widen as well.

The bottom line: Investors would do well to understand the nuances of each fund before investing.

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