ESG investing: Predictions for 2023 from top fund managers

It has been a challenging year for investors given the volatility across almost every asset class.

While the tech rout has made headlines, those who care about investing sustainably are also quietly nursing losses.

Once the darling of the investment world, ESG funds have fallen out of favour this year, with investors pulling more money than they added for the first time in more than a decade.

Performance has been sluggish as they grapple with inflationary pressures, the shift to value stocks and growing scepticism surrounding just how ‘green’ funds are.

We speak to the fund managers of some of the top green funds about how they think 2023 might pan out for sustainable investment. 

Why have ESG funds struggled this year?

2022 has been more challenging for sustainable funds as inflation and rapidly rising interest rates precipitated a rotation from growth into value.

While ESG funds had become somewhat of a darling of the investment world during the pandemic, the AIC’s environmental sector has returned -24.3 per cent this year.

This is because ESG funds tend to have a bias towards growth and are usually weighted to small and mid-cap indices, which have underperformed.

Defensive stocks like oil, mining and tobacco have instead enjoyed stellar performances but are excluded from the investment universe for many ESG fund mandates.

As well as the investment style falling out of favour, external factors have made it even more challenging for companies focused on building sustainable solutions.

‘Environmental solutions are generally physical products which draw on complex global supply chains, so the disruption to these networks has been challenging,’ says Jon Wallace, investment manager of Jupiter Green Investment Trust.

‘Inflation has also made it harder for green technologies to become cheaper as they scale – for example sectors such as renewable energy and electric cars have actually increased prices to protect margins and balance against rising cost pressures.’

Jon Forster, portfolio manager of Impax Environmental Markets also points to the weakness in cyclical sectors such as water infrastructure and buildings energy ‘both of which have exposure to weakening construction activity.

‘Ultimately, the above rotation has led to a substantial de-rating of the portfolio valuation back to long term average levels, and despite strong earnings delivery with clear demonstration of pricing power, and a strengthening long-term investment story in the wake of the Russia/Ukraine conflict.’

What will drive performance in 2023?

While ESG funds may have suffered in 2022, portfolio managers think this year has cemented the need for investment into sustainable companies.

Wallace says: ‘We believe that solutions to environmental challenges are now central to global development and no longer deemed a ‘nice to have’ but instead are regarded as integral to future economic activity.

‘The great energy shock of the last 18 months – and the critical role that “clean” solutions are playing in responding to the long-term challenges of energy security, affordability and climate change – serve to highlight the crucial importance of environmental solutions in solving these unavoidable and era-defining issues.’

But that does not come without its challenges.

While inflation has shown signs of slowing, uncertainty around whether central banks will continue to hike interest rates remains.

Impax Environmental Markets concedes that the outlook is ‘challenging’ but believes a lot of the headwinds ‘are priced into the valuation of portfolio holdings and that progress through these risks has potential to unlock material performance for IEM, given its growth bias and overweight positioning in Europe.’

Reasons to be positive 

There are reasons to be positive even with a recession looming, says Peter Michaelis, head of the Liontrust Sustainable Investment team.

‘We are more excited about the prospects for the coming twelve months than we have been in years,’ he says.

‘This confidence comes from the strength of our 20 sustainable investment themes and the quality of the businesses aligned with solving critical sustainability challenges. We believe that sustainable companies have stronger growth prospects and better management than the market appreciates.’

There are significant tailwinds for sustainable businesses moving forward as the need for energy efficiency and security becomes even more important.

Impax’s Forster says: ‘Accelerated uptake of renewable energy will have an important role to play longer term as Governments remove current obstacles in permitting. Whilst painful in the near term, the current crisis will accelerate the transition away from fossil fuels towards a cleaner more energy efficient economy.’

Wallace also highlights food security as a key investment theme, which he thinks will become more of a priority for governments in 2023.

‘Knock-on impacts for food security are already being felt globally and the agricultural industry is ripe for adoption of solutions to solve these sustainability-linked problems, via both novel and existing commercial technologies and services,’ he says. 

‘We expect food systems will come under greater pressure and scrutiny in the coming year as the connected issues of affordability, security and sustainability continue to challenge the sector, creating opportunities for investment in solutions to these problems.’