Lee Clements
The widely known quote “It’s not easy being green” is often used in sustainable investment (‘SI’) circles. However, with the challenges SI faced in 2022, some commentators professed an ‘ESG downturn’. We look at the numbers to see how easy or hard it was to be green in 2022.
In 2022 most SI indices indeed underperformed their benchmarks, after significant outperformance in 2020 and 2021. However, in both equities and the fixed income, it is noticeable that the most visible, ‘greenest’ areas of SI, green economy equities and green bonds were the areas of the largest underperformance. FTSE Environmental Opportunities All Share, which is focused on companies with more than 20% exposure to the green economy, was down 6.2% relative to the FTSE Global All Cap.
FTSE World Broad Investment-Grade (“WorldBIG”) Green Impact Bond Index was down 5.5% relative to the FTSE WorldBIG. These were hit, as was the rest of the market, by rising interest rates hitting growth stocks and bonds with longer durations. These were also the areas of the greatest outperformance in 2020 & 2021 and had built up valuation and duration headwinds, so underperformance is not surprising and indeed green equities underperformed in 5 of the 6 main market downturns in the last 22 years. The comparison became even more painful when compared to the strong performance of the fossil fuel sector in 2022 (in equities at least, investment-grade energy corporate bonds underperformed in 2022).
Selected SI Equity Indices - Performance of Selected SI Indices Since Pandemic
Source: FTSE Russell, as of 31 Dec 2022. Past performance is no guarantee to future results. Please see the end for important disclosures.
Selected SI Fixed Income Indices - 2022 Performance of Selected SI Indices
Source: FTSE Russell, as of 31 Dec 2022. Past performance is no guarantee to future results. Please see the end for important disclosures.
However, despite their visibility, these areas are far from the only parts of the SI market, with many other strategies focused on climate or broader ESG. These are typically less volatile and whilst the majority of them underperformed in 2022 it was generally by a lower margin of ~1-2%. FTSE Developed Paris Aligned (PAB) Index was 1.5% behind FTSE Developed Index, whilst the Climate Risk Adjusted WGBI Index was 0.8% behind the FTSE WGBI. Some SI strategies were ahead of the market, typically the ESG strategies which are more value orientated and have higher yields. FTSE4Good All World Index was 1.2% ahead of FTSE All World Index and FTSE WorldBIG ex Fossil Fuels Enhanced Bond Index was 0.2% ahead of FTSE WorldBIG Index.
After the popularity of green strategies in 2020 and 2021 they built up valuation's premiums over the broader market, which have narrowed in 2022, which can be seen as a healthy reset.
Fwd PE ratio - SI Indices
Source: FTSE Russell, as of 31 Dec 2022. Past performance is no guarantee to future results. Please see the end for important disclosures.
Fund Flow
Another key question for 2022 is whether it leads to investors pulling funds out of SI strategies. This is a particularly pressing question given the significant levels of climate finance which will be needed to put the world on a 1.5oC trajectory. Looking at the UK SI market we can see that the fund flow only really turned negative in Q3 and the SI market fared better than the conventional market, which was negative throughout the whole year.
UK Ethical flows by asset class
Source: Lipper, as of 31 Dec. 2022. Past performance is no guarantee to future results. Please see the end for important disclosures.
UK Ethical v Conventional flows
Source: Lipper, as of 31 Dec. 2022. Past performance is no guarantee to future results. Please see the end for important disclosures.
Similar to the issuance markets we saw green bond volumes fall, particularly in Q4, but again this was in line with broader markets. Green bonds maintained their position as 4-5% of total bond issuance in 2022, up from 1-2% in 2017-18.
Green Bond Issuance
Source: FTSE Russell, as of 31st December 2022. Past performance is no guarantee to future results. Please see the end for important disclosures.
Whilst there was some pushback on SI, particularly in certain US states, overall SI policy and regulations have continued to roll forward, with new requirements continuing around the world, particularly on disclosure.
So overall we would say that despite being a challenging year, 2022 was not as painful as first thought and it passed the tests which were placed on it with collapsing or investors walking away. Indeed, we see the market continuing to be very active.
And what will happen in 2023? It’s difficult to forecast, but if interest rates and inflation stabilise then many of the 2022 headwinds may become tailwinds. However, the higher levels of volatility and dispersion versus the broader market is likely to continue as the SI market copes with the pressure from regulators and stakeholder to differentiate funds continues, disclosure increases and the SI data collected in 2023 starts to pick up the many challenges faced by companies in 2022, such as inflation, conflict and geopolitics.
As more investors adopt sustainable investing strategies, they are finding that “being green” isn't too hard, but it's never a breeze.
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