The recent surge in fossil fuel stocks on the back of the Ukraine war might suggest that investors’ long embrace of climate-friendly companies is starting to cool.
But, as far as affluent UK private investors are concerned, that is not the case, say wealth managers.
While some clients have reframed their approach to energy investments in the light of the crisis and the jump in oil, gas and coal prices, most remain committed to the net zero agenda and, more broadly, to companies that take account of environmental, social and governance (ESG) values.
Wealth managers told FT Money that investors remained committed to sustainability despite the “short-term headwinds” against it.
Admittedly, big ESG-based funds have been battered with the tech-heavy Parnassus Core Equity Fund, down 23 per cent this year and iShares ESG Aware, down 24 per cent.
But, more broadly, global ESG indices are holding up fairly well in the market turmoil this year: the MSCI global ESG Focus Index is down 14.7 per cent since the start of 2022, the same as the all-stocks MSCI World index.
Ben Palmer, head of responsible investment at wealth manager Brooks Macdonald, says: “Over longer timeframes we believe the structural drivers behind the sustainability trends at both a policy and consumer level will be important tailwinds. Although there is a lot of uncertainty in markets over the near-term direction of travel, we have not seen a deterioration in the longer-term support.”
He adds: “The tragic events in Ukraine have driven a significant rise in oil and gas prices, but they have also driven an increased commitment from global policymakers to accelerate their development of renewable energy capacity, in an effort to gain greater energy independence.”
Catherine Hampton of Cazenove Capital adds: “The elevated valuations of many sustainable companies have moderated over the past 18 months and we feel the long-term growth prospects and strong momentum of these companies remain attractive, particularly given the regulatory and policy environment as governments take action to tackle climate change.”
The EU’s response to the current energy security crisis includes a doubling of solar capacity by 2025 and a tripling of green hydrogen, compared with what was planned before the war in Ukraine, she says.
Richard Flax, chief investment officer at Moneyfarm, the online investment adviser, says a derating of the valuations of high-growth businesses in the past few months — for example Microsoft, Tesla and Nvidia — had negatively affected some ESG indices.
“However, a responsible investment approach has a long term and strategic focus and this is clear to most of the clients, who understand that a six-month period is not enough to affect the structural change that financial markets have seen in the recent years,” he says.
Max Richardson, head of sustainable finance at Investec, the wealth manager, says investors may also not recognise the risk of fossil fuel reserves staying in the ground if policy and consumer attitudes accelerate towards achieving net zero, the policy of cutting greenhouse emissions.
Other managers pointed to a spread of tastes in the market — with a diehard core of ESG investors committed to investing in the sector — regardless of the cost.
Morningstar data show major ESG-labelled companies still have higher price/earnings ratios than average — suggesting investors expect strong growth rates in the future — though they are not as high as previously. The MSCI ESG focus index trades on a forward price/earnings ratio of 16, about the same as the MSCI world index.
Nicolas Ziegelasch, at Killik & Co, says: “We think ESG investing is predominantly driven by investor preferences for the type of investing rather than a valuation basis, and current high valuations don’t seem to be impacting client flows.
He predicts that more companies will seek to organise themselves under the ESG banner — and the premiums commanded by ESG stocks may fall. He says: “Over the longer term, the money flow into the sector will drive more businesses to report ESG metrics properly and act to improve their ESG metrics, thereby increasing the pool of investments for ESG investors and hence reducing the scarcity premium applied to ESG investments.”
Some managers believe investing sustainably isn’t just a case of ploughing money into low carbon firms, as shunning fossil fuels and less sustainable businesses will create other economic and social problems, as well as reduced funding for those in transition.
Guy Foster, chief strategist at Brewin Dolphin, says: “Under-investment in energy without a reliable alternative is contributing to a surge in fuel poverty.”
Karen Ermel, director of responsible investing at Coutts, says: “Simply moving from fossil fuel businesses to solar farms won’t make the biggest difference for our investors, or for the planet. Doing this would ignore those companies that need support to transition to a net zero economy, and already have credible plans to do so, even if they are not there yet.”
Killik & Co says clients who previously wanted no exposure to fossil fuel are relaxing that restriction, a trend also seen in the wider market, reflecting a growing acceptance that the rundown of fossil fuel investments is funding a shift to renewables for some companies.
The debate has called into question how ESG funds should be defined as managers have different criteria for qualifying funds, with various degrees of inclusion of fossil fuels.
Gemma Woodward, at Quilter Cheviot, says: “For some strategies, investing in fossil fuels would not be within their remit, for others taking an engagement rather than divestment approach is appropriate. It is not one size fits all.”
Ryan Hughes, head of investment research at Manchester-based AJ Bell, adds: “Two funds with the same name, such as sustainable growth, could invest in very different ways and have quite different risk profiles. At the moment this makes it difficult for investors appropriately to compare ESG funds without really getting into the details, which many private investors will not have the inclination to do.”