Joeri de Wilde: Sustainable investing is no longer a hype

July 9, 2024

^{This column was originally written in Dutch. This is an English translation.}

By Joeri de Wilde, Investment Strategist at Triodos Investment Management

Sustainable investing is steadily developing from hype to mainstream. This includes a normalization of stock market valuations and fund flows. That is not a worrying step back, but rather a next phase on the road to adulthood.

At the end of 2021, sustainability was still the hype on the trading floor. The sustainability enthusiasm among investors reached a temporary peak and this was reflected in the enormous inflow into sustainable investment funds and the highly inflated stock prices of, for example, green energy companies. Every company report was full of the buzzwords 'ESG' and 'sustainability'. Due to the inevitability of the sustainable transition, the sky seemed to be the limit.

From sustainability to AI

But nothing is as fleeting as investor enthusiasm. In 2023, sustainable investment funds recorded a significant outflow. And the relative performance on the stock market also points to a decline in enthusiasm since the beginning of 2023. For example, two indices specially compiled by Société Générale, which should benefit from the global energy transition and the European Green Deal, have been performing worse than their respective benchmarks since the beginning of last year.

This change started, not entirely coincidentally, around the rise of ChatGPT, which ushered in the AI ​​hype among investors. Since then, it has been AI that has made investors' hearts beat faster and sustainability seems to be disappearing further and further from the picture.

The political 'move to the right' probably also plays a role in this. Investors foresee a difficult period for sustainable investing. The Green New Deal Index of Société Générale indeed fell sharply after the victory of the radical right in the European Parliament elections. And in this globally important election year, investors on balance withdrew money from ESG equity funds for a longer period of time for the first time. This has led to rumors that sustainable investing is on the decline.

From infancy to adulthood

This seems to me to be a wrong interpretation of recent developments. Every hype comes to an end, but the question is what happens after such a hype. Will money flows dry up completely, or will there simply be a normalization of valuations and money flows, after which growth can continue? If we look at the facts, the second seems to apply to sustainable investing.

Firstly, recent developments in the financial markets reflect the development that many sustainable industries have undergone. For example, five years ago the green energy industry was still largely in its infancy worldwide. As a result, there were enormous growth expectations, which justified higher price-earnings ratios.

To illustrate: in China, an average annual profit growth per share of 35-40% was expected at the time for Green Transition Industries, such as manufacturers of electric cars. The biggest growth spurt is now behind us and growth expectations have fallen to around 15% per share. That is still a significant profit growth expectation, but this decline logically translates into lower stock prices and valuations.

Secondly, legislation and regulations have been considerably tightened in recent years. The EU reporting requirements under the Sustainable Finance Disclosure Regulation (SFDR) now ensure that greenwashing is less possible and the recent rules regarding the naming of funds will further contribute to this. The fact that this reduces the total amount of money managed by 'sustainable' funds, temporarily or permanently, because funds no longer fall into the sustainable category, should therefore be seen as a step forward. The time of the proliferation of funds with dubious sustainability claims is increasingly behind us.

This touches on the third point: despite the extinction of the stock market hype, there is increasing social awareness that the sustainable transition is truly inevitable. This is evident from the increasing interest of institutional investors such as pension funds and universities in sustainable investing. The associated mandates are not included in data on fund flows, but they do suggest that a structural change is taking place in society.

In the meantime, sustainability risks have become undeniably material (from drought to floods), which means that every investor must now take them into account with a view to simple risk management, sustainable goal or not.

Incremental normalization

The normalization of sustainable investing is therefore proceeding step by step. The current phase of declining cash flows and lower stock market valuations is accompanied by a broader social awareness that sustainability risks are material and the transition truly inevitable. The fact that we are beyond the hype and have reached this next phase is anything but bad news: it means that sustainable investing has come one step closer as the new normal.