Sustainable investment at a crossroads: beyond ESG
Andy Howard, Global Head of Sustainable Investment at Schroders, reflects on the backlash to sustainable investing and the importance of distinguishing between social challenges and investment drivers.
Talk of the “ESG backlash” has dominated sustainable investment circles over the last year or two. It’s tempting to treat the shift in headlines, fund flows and focus as a pause, or as growing pains, which will reverse once political winds change and common sense prevails.
Such simplifications – of the challenge or the solutions – miss the mark in our view. Sustainable investment faces more existential questions. While a lot of the sustainable investment field is focused on terminology – re-assigning the meaning of E, S and G or re-labelling “sustainable” to “resilient” – re-badging the field is less important than being clear about objectives and approaches to delivering those objectives.
At Schroders, our purpose is to “create prosperity together”, which means working with our clients to deliver the investment outcomes they expect, using our commitment to interrogating key investment challenges. In sustainability terms, this means looking past superficial screens for “good” investments.
Three key areas stand out:
- Differentiating between issues
The finance industry has not always found it easy to be clear about the distinction between social challenges and investment drivers, or between investing to manage risks and investing to promote positive change. The business and investment case for tackling many social challenges is clear and strong. For example, the policy support for clean energy technologies, and the ~90% and ~70% declines in solar and wind generation costs over the last decade1 as their use has expanded, has led to renewable energy becoming the lowest cost source of new power capacity. As a result, 91% of all new renewable projects in 2024 delivered electricity at lower costs than fossil fuel alternatives2.
Across the Schroders group, our emphasis is on the areas of greatest investment importance. In 2021, we announced that all the strategies we manage across Schroders had established and documented their approaches to integrating sustainability factors into investment decisions3.
In practice, this means each team can articulate how they identify issues they consider relevant, examine them, apply that analysis to investment decisions and engage with portfolio investments. We emphasise casting a wider net of analysis, rather than restricting investment, integrating structured analysis with the judgement and collective insight of our investment teams.
Many investors will continue to prioritise investment in the most socially important areas, and we have worked with many clients to help them do so, through analysis of how that prioritisation can affect investment performance, and by designing strategies to mitigate trade-offs.
- Investing in change and improvement
Sustainable investment has largely been defined as a characteristic, rather than an outcome which is unlocked over time. Regulation has largely pushed the industry further in this direction in recent years, typically demanding that sustainable portfolios focus on companies or investments which are already sustainable, rather than on the improvement they deliver.
Our focus is also turning increasingly to transition over leadership – identifying the companies or assets in the strongest position to improve in the future, and using our voice and influence to encourage and support that change. While the market does not reward improved performance in all areas equally, in most common areas of sustainability it has rewarded improvement more richly than sustained leadership. For example, whereas companies with the lowest carbon emissions have slightly underperformed the market over the last five years, those which have decarbonised most quickly have delivered close to 4% annual outperformance over that period.
Improving companies also deliver the strongest and most value real world outcomes. Building a portfolio of companies with already-low carbon emissions, or strong sustainability practices provides an optically “sustainable” portfolio but does little to contribute the transition needed in so many areas of society and its impact on the environment.
- A web of change
Perhaps the biggest challenge of all is that disentangling the myriad structural trends driving global economies, industries and investment portfolios into individual issues which can be examined in isolation risks missing key risks and opportunities.
For example, the growth of AI presents significant opportunities, not least in delivering innovations to tackle environmental challenges. However, that growth also places huge stress on energy infrastructure and represents over 10% of annual greenhouse gas emissions growth. There is also the threat of social impacts as the most highly valued skills change more quickly than workforces can adapt. Examining any of these issues in isolation, without considering its impacts and causes, risks missing an important part of the picture.
Tackling this is clearly challenging. While it is instinctive to try to distil complex challenges into simplified views – focusing on one issue at a time and considering a limited number of potential scenarios – in practice systems thinking is becoming increasingly important.
By prioritising a comprehensive view of long-term sustainability factors in our investment processes, we aim to cast a wider net, encompassing causes and consequences, in our analysis. But advances in technology promise opportunities to bring a more structured lens to this holistic view of the world and the spectrum of futures it holds.
2 IRENA report: 91% of new renewable projects now cheaper than fossil fuels
3 Schroders Completes ESG Integration Process
4 Based on our analysis of MSCI ACWI constituents, ranking companies annually according to their scope 12 carbon intensity and selecting either the companies with the lowest average intensity over 2019-24 relative to sector peers, or those with the fastest reduction relative to peers.
