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Zacks Advantage Blog

Is “sustainability” an investment trend or a fad?

October 1st, 2021 | Posted in Investing

Is “Sustainability” a Durable Long-Term Investment Trend?

Readers of this column may be familiar with some of the buzzwords floating around the business world these days: sustainability, sustainable investing, and Environmental, Social, and Governance (ESG) investing – to name a few. All of these terms frame what might be considered a ‘movement’ in the corporate and investment world. The terms describe the emphasis being placed on factors like environmental impact, responsibly sourced materials, fair working conditions, and diversity.1

Some investors may think the shift to sustainability and “ESG” principles is wonderful and much needed. Others may see it as overkill. But the question for long-term investors should be whether the ‘sustainable investing’ category is a durable long-term trend that could span years or decades, or whether it’s just a fad.

In this edition of Investor’s Advantage, we’ve got three reasons investors may want to see sustainable investing as a long-term trend that’s just getting started.

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Reason #1: The Sustainability Theme May Not Be Fully Priced into Stocks

The sustainability theme is not new, and some investors may argue that high expectations are already starting to bake themselves into stock prices. Enthusiasm for a company like Tesla, for instance, has driven its stock price to an astronomical valuation as many investors bet it will become one of the most profitable companies in the world.

The implication of the investor “green rush” is that sustainable investing may not offer much upside in the future and that investors in sustainable companies may need to accept a lower reward for the same amount of risk going forward. In other words, investors are being forced to choose between sustainable investing and return potential.

But there are good reasons to believe the opposite could ultimately prove true. The road to sustainability for many companies is just beginning, and it seems fair to assume many of the sustainable companies of the future are yet to be formed. According to Blackrock, the “markets are a long way from fully pricing the far-reaching consequences of changing attitudes towards sustainability: the impact will be more pronounced on some assets than others, and some assets will likely disappear altogether as sustainable preferences are embedded into market pricing.”

Another way to think about this potential dawn of sustainable investing is to compare it to tech in the 1990s versus tech today. We know looking back that the 1990s was the beginning of an economic transformation driven by technology. Many companies formed in the early days no longer exist. But many have since thrived, and new companies are being formed every year as the trend continues. The biggest, most profitable companies in the world today were almost all borne from a trend that started 30+ years ago.

Reason #2: Follow the Fund Flows

The idea that sustainable investing is a trend versus a fad is somewhat subjective. Looking at fund flows, however, paints a more objective picture of how investors are viewing the sustainability/ESG trend.

The chart below illustrates the gradual march higher of assets under management dedicated to ESG funds. Over the last decade, it’s clear to see equities have charted the biggest growth. As Blackrock notes, “because these flows are in their early stages, the full consequences of a shift to sustainable investing are not yet in market prices. Assets backed by high sustainability will become more expensive while others will become cheaper during the transition period, in our view, meaning that those holding sustainable assets will earn a return benefit during this transition.”

As more investors flock to the ESG category, companies that are investing in sustainable practices could benefit from fund flows, and “companies with low perceived levels of sustainability may switch to more sustainable practices that are valued more highly by the market over time,” according to Blackrock.

Reason #3: The Impact of Demographics, Wealth Building, and Worldview

The final reason sustainable investing may be a trend versus a fad: demographics. According to the most recent U.S. Census, the 10 most common ages in the country are between 25 and 40. As the chart below shows, the new few decades should usher in a transfer of wealth from boomers to Millennials and Gen Xers.

Younger generations tend – at least for now – to care more about sustainability and issues with the environment. Blackrock also argues that the number of natural disasters causing $1 billion or more in damages has been on a steady path higher, meaning younger generations are exposed more to dramatic events like wildfires, flooding, and heatwaves. These ‘negative shocks’ may harden younger generations’ interest in sustainability.

Going back to Reason #1, the durability of younger generations’ interest in sustainable investing may not be fully priced into stocks yet. Academic studies have found that financial markets do not necessarily price-in long-term trends far off into the future, meaning that there still could be plenty of slack in pricing related to sustainable investing.

Bottom Line for Investors

Sustainable or ESG investing is certainly a trend worth noting and observing looking ahead into the future. As was the case in the early stages of the technology boom, however, not all companies will prove successful, and there is still likely room for many new entrants. What’s more, many existing companies are likely to step up sustainability efforts, which could create entirely new barriers to entry but also potentially increase investor interest in a company that’s been ‘re-imagined.’ As summarized by Blackrock, “society will care much more about sustainability in the future than it has in the past, and this will be the key driver of investment flows and asset returns.”

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1 Black Rock. February 2020. https://www.blackrock.com/corporate/literature/whitepaper/bii-portfolio-perspectives-february-2020.pdf

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