Sustainable investing’s value proposition remains compelling
The US Forum for Sustainable and Responsible Investment Foundation (SIF) recently released its annual survey of sustainable investment (SI) assets under management (AUM), finding that, as of year-end 2019,
$17 trillion of assets were managed sustainably in the US, a 42% growth since 2018. 2020 is on track to set new records for SI AUM. The latest data analyzed by Goldman Sachs finds that, as of October 2020, USD 56bn is invested in European Sustainable ETFs, more than double the USD 27bn invested at the start of 2020. Given such strong inflows, questions have arisen about the risk of a valuation bubble in the most popular holdings in these SI funds. But we believe this is not the case, for these reasons:
1. Valuation premium expansion is in line with quality and growth bias. Since the start of 2020, valuation premiums for the most common stocks in environmental, social, and governance (ESG) leaders funds have widened. But there is high overlap between typical ESG leaders benchmark constituents and quality and growth stocks, which have also experienced an expansion in valuation premiums this year. ESG leaders indexes also tend to have high exposure to the tech sector, where valuation multiples have increased in 2020. Overall, based on our analysis using data from Bloomberg and Goldman Sachs Investment Research, relative valuation multiples for commonly held names in
ESG funds have not expanded by more than names commonly held in other types of strategies or asset classes, making it unlikely that ESG strategies are uniquely overvalued.
2. Cyclical rotation may trigger short-term underperformance, but a “bust” is unlikely. We expect a broadening of the equity market rally into year-end, with cyclical sectors likely to catch up to the strong outperformance of mega-cap tech stocks so far this year. Popular ESG leaders strategies could see short-term underperformance in this scenario.
While SI cannot be viewed independently of fundamentals, our preference for SI is based on maximizing long-term risk-adjusted returns. Accordingly, we do not anticipate any potential underperformance leading to a “bust.”
3. Thematic approach remains well-supported. Some specific themes, such as renewable energy and greentech, have outperformed this year in anticipation of announced and pending recovery spending from multiple countries in the space.
Although valuations have risen, we think the earnings outlook for the longer-term themes remains favorable over the long run. As a result, there remains scope for earnings delivery that may support richer valuations for longer.
Considering these factors, we do not believe there is a risk to the fundamental value proposition of SI as an approach that maximizes longterm risk-adjusted returns. Increased government, business, and consumer emphasis on sustainability, combined with a growing investable opportunity set, means sustainable investing is now our preferred.