What is ESG Investing?
We live in a time in which it is not only the risk and reward ratio of an investment that counts, but other factors come into play as well.
This has especially been obvious in the meteoric rise in ESG investing in recent times.
To put it simply, ESG stands for Environmental, Social, and Governance. Those are the three non-financial factors that investors increasingly consider before making their investing decisions. Using ESG factors, investors can both positively impact society while still making money off their investments.
Examples of each component of ESG may include:
- Environmental – Focusing on renewable energy, reducing the carbon footprint, reducing waste, responsibly using energy and resources, etc.
- Social – Focusing on human rights, data privacy, racial and gender diversity in hiring practices, treating employees fairly, involvement in the community, etc.
- Governance – Focusing on the board composition, limiting corruption, aligning incentives for the executive compensation schemes, protecting whistleblowers, etc.
ESG Investing Statistics
1. The ESG market is already huge, and it’s growing rapidly ($41 trillion at the end of 2022)
ESG investing has been on the rise in recent years as more investors prioritize non-financial factors when making investing decisions. According to Bloomberg Intelligence, the global total of assets under management in ESG-related funds is around $41 trillion. That’s up from $22.8 trillion in 2016. Bloomberg Intelligence also estimates that ESG-related investments will surpass $50 trillion by 2025.
2. Europeans are leading the way in ESG investing (83% of total ESG assets), while North Americans remain skeptical
Europe is far ahead of other regions in terms of ESG investing. According to Bankrate, Europe has a whopping 83% of all the ESG assets under management (AUM), with over $2 trillion. To put it into perspective, it holds almost five more times ESG assets than all the other regions – combined!
It is no surprise since 31% of European investors said ESG is central to their investment approach, compared with 18% of investors in North America in a Capital Group report. There have been more than $40 billion of capital inflows in ESG funds in Europe’s 4th quarter of 2022 alone, with the US posting $6.2 billion of outflows in the same time frame. In Europe, just 6% of investors say they’re yet to be convinced about ESG investing, compared with 20% of investors in North America.
3. ESG funds survive longer than non-ESG funds
Sustainable funds have greater survivorship rates than non-ESG funds. On average, 77% of ESG funds that were available 10 years ago still exist compared to 46% for traditional funds. This can be explained by a number of factors, ranging from performance to investors’ expectations and motivations.
4. The majority of investors (89%) consider ESG issues when making decisions, while only 13% see it as a passing fad
The vast majority (89%) of investors consider ESG issues in some form as part of their investment approach, according to the aforementioned Capital Group study. It found that the growth is largely driven by clients and reputational concerns rather than deeply held beliefs by the investors.
The same research shows that only 13 percent of global investors see ESG as a “passing fad that will eventually go out of fashion.” This shows us that ESG investing is already mainstream and is here to stay.
5. ESG funds perform better than non-ESG funds
According to Morningstar, ESG investments have outperformed relative to non-ESG funds over the 5 year period 2017-2021. According to Morningstar, 57% of ESG equity funds beat their category index. Over a 3-year period, 63% of ESG equity funds outperformed their category index.
A McKinsey survey of 2,000 companies found that ESG factors resulted in positive impacts on equity returns 63% of the time. The survey found that the positive effects are due to ESG investments facilitating top-line growth, reducing costs (including regulatory and legal costs), increasing employee productivity, and streamlining capital expenditures.
In another PwC survey, 90% of asset managers surveyed believe that integrating ESG into their investment strategy may improve overall returns. Another 60% reported that ESG investing has already resulted in higher performance yields compared to non-ESG equivalents.
Keep in mind that there is some conflicting evidence on this topic (more in the next statistic).
6. ESG funds underperform non-ESG funds
According to a National Bureau of Economic Research (NBER) paper, four conclusions can be made about ESG investing:
- Investors generally expected ESG investments to underperform the market (on average -1.4% on a 10-year period annualized);
- There are substantial differences across investors in their ESG return expectations and their motives for ESG investing: 45% of survey respondents do not see any reason to invest in ESG, 25% are primarily motivated by ethical considerations, 22% are driven by climate hedging motives, and 7% are motivated by return expectations;
- The highest ESG portfolio holdings are among individuals who report ethics-driven investment motives;
- Financial considerations matter independently of other investment motives: meaningful ESG holdings are found only for investors who expect these investments to outperform the market, regardless of their reported motives.
7. The biggest challenges in ESG investing are: performance concerns, lack of robust data, and greenwashing concerns
According to the Capital Group’s 2022 ESG study, when it comes to ESG funds, investors are mainly concerned with performance, lack of data, and greenwashing. The first two are tied together in a way, and the jury is still out. We just don’t have enough data at the moment to make a final judgment in the ESG vs. non-ESG performance debate.
Greenwashing is lurking in the back, especially with more and more companies pushing for ESG practices to better their public image. The lack of standardized rating systems doesn’t help in this regard. However, fewer investors in 2022 thought that asset managers mainly used ESG as a marketing and PR tool to generate sales (55% vs. 59% in 2021). The falling trend is most apparent in the Asia-Pacific region (48% vs. 59% in 2021), according to a 2022 ESG global study by Harvard.
A former director of sustainable investments at Blackrock Tariq Fancy thinks that Wall Street is greenwashing the investment world, making it mostly PR and distracting from the climate change problem.
8. Younger investors tend to focus more on ESG issues than older investors
Roughly 80% of Gen Z/Millenial, 60% of Gen X, and just 30% of Baby Boomer investors said that their investment firm should influence companies’ ESG policies or practices even if doing so decreases the value of their investment, according to a Stanford University study.
An average investor in their twenties or thirties is willing to lose between 6 percent and 10 percent of their investments in the interest of companies improving their environmental practices, while the average baby boomer was unwilling to lose anything, according to the same study. The study found young wealthy investors to be the primary drivers of ESG investing.
9. More than 400 companies have signed the Climate Pledge and with a good reason
Companies are increasingly incorporating sustainability practices and goals. Perhaps the most known and formal of these is the Climate Pledge, currently signed by over 400 companies. While this can be partly explained by marketing/branding purposes, companies actually have a monetary incentive to do so: Climate-related weather events are expected to cost businesses $1.3 trillion by 2026. according to CDP.
10. Only 50% of companies believe they are performing well on E factors, 39% on G factors, and 37% on S factors
According to NAVEX Global, only 50% of companies believe their company performs very effectively against environmental metrics. Worse yet, only 39% believe their company performs well for governance and 37% for social issues. This shows that companies have a long way to go to improve in the ESG area and are aware of their flaws.
11. Three companies are leading the way in ESG: Bank of America, NVIDIA, and Microsoft
Bank of America, NVIDIA, and Microsoft took the top 3 spots in nonprofit research organization JUST Capital’s 2023 rankings based on ESG metrics. Keep in mind that various systems are deployed in measuring ESG metrics, each with varying results. A more standardized reporting framework and regulation around the topic are desired by many investors.
12. Consumers are also “voting” on ESG issues with their spending, not just their investing
76% of consumers say they will stop buying from companies that treat the environment, employees, or the community in which they operate poorly, according to PwC. This just shows that consumers are becoming aware of their power in their financial decisions, be it spending or investing.
13. 85% of asset managers see ESG as a high priority, but 64% also show concern
85% of asset managers say ESG is a high priority for their companies, but 64% were concerned about a lack of transparency and corporate disclosure on firms’ ESG activities, according to the Index Industry Association. This shows that the era of ESG is already in full swing, but not without certain concerns.
14. The three most important elements in ESG reporting are clarity on ESG’s role in the investment process, reporting on specific E, S, and G factors, and third-party validation and review
In the aforementioned Capital Group report, the top three elements of ESG reporting cited by global investors were clarity on ESG’s role in the investment process, reporting on specific E, S, and G factors, and third-party validation and review. Some other elements, such as carbon footprints, UN Sustainable Development Goals, stewardship reports, proxy voting outcomes, and case studies, were seen as less important by global investors.
15. ESG classifications vary between different companies
16. The demand for ESG products is outstripping supply: 30% of investors struggle to find attractive ESG products, while most asset managers prioritize converting existing products to ESG products
According to a PwC report, 30% of investors say that they struggle to find attractive and adequate ESG investment opportunities. A whopping 88% of institutional investors surveyed believe asset managers should be more proactive in developing new ESG products. However, less than half, 45%, of managers said they plan to launch new ESG funds. Instead, a majority of asset managers surveyed, 76%, said their immediate priority is converting existing products so they can be labeled as ESG-oriented.