ESG funds and green bonds broke records in 2021. According to Morningstar, ESG fund flows hit nearly $55 billion in Q3 2021, surpassing their haul for the whole of 2020. Meanwhile, the Climate Bond Initiative predicts that green bond issuances will reach $400 billion to $500 billion in 2021, nearly double the record-high $270 billion in 2020.
The increasingly apparent effects of climate change and rising social instabilities will accelerate these trends in 2022. At the same time, new regulations and evolving investor interest could bring about new ESG investment themes that have a more significant impact on climate change, social justice, and corporate governance.
Let’s take a look at three ESG investment themes that could take off in 2022 and how to add exposure to your portfolio.
Most ESG investments are exclusionary, meaning they exclude non-ESG-friendly companies, but the remaining companies don’t necessarily actively promote ESG goals. For example, the Vanguard ESG U.S. Stock ETF’s (ESGV) top four holdings are Microsoft, Apple, Amazon, and *Alphabet*– companies that are not actively combating climate change.
Inclusionary funds seek out companies that actively improve ESG outcomes. For example, the JPMorgan Climate Change Solutions (TEMP) actively finds companies developing solutions to address climate change. Unlike ESGV, the fund’s top holdings include Schneider Electric, Trane Technologies, and other renewable energy companies.
Other inclusionary ESG funds include:
The iShares MSCI Global Impact ETF (SDG) invests in companies whose operations further the UN Sustainable Development Goals by generating at least 50% of their revenue from products and services that meet those goals.
The Pax Ellevate Global Women’s Leadership Fund (PXWEX) invests in 400 gender-diverse companies and has outperformed more than three-quarters of its global equity peers over the past three years.
The TIAA-CREF Core Impact Bond Fund (TSBRX) invests in investment-grade bonds from companies with a direct environmental or social impact.
Inclusionary funds are an excellent way for investors to support companies addressing climate change, but they don’t influence the behavior of fossil fuel companies. And, ultimately, changes at these large fossil fuel companies will be essential to reach climate goals. Therefore, even these funds have a limited impact on climate goals.
Activist funds aim to make changes at fossil fuel companies. For example, the Engine No. 1 Transform 500 ETF (VOTE) launched a successful proxy battle to replace three ExxonMobil board seats with climate-friendly members. These new board members are in a great position to push the company to accelerate its transition to renewable energies.
In addition to activist funds, new Department of Labor rules could enable pension funds to vote proxies in favor of ESG proposals. As a result, investors might start looking at the ESG track records for these funds when making investment decisions, adding another dimension of analysis when evaluating different investment opportunities.
The United Nations COP 26 underscored the central role that nuclear power will play in addressing climate change. However, despite the importance of nuclear energy, most ESG funds avoid nuclear power companies due to concerns over toxic waste. The irony is that nuclear power has a high capital requirement and benefits from investment.
ESG investors increasingly recognize the importance of nuclear energy and will look for exposure in their portfolios in 2022. For example, the VanEck Uranium+Nuclear Energy ETF (NLR) is one of the few ETFs providing nuclear power exposure through investments in uranium stocks and utilities that invest in nuclear power plants.
Investors will continue to add exposure to ESG in 2022 and beyond. Rather than simply excluding non-ESG companies, investors will seek ways to actively invest in companies supporting ESG goals, taking action at fossil fuel companies, or supporting nuclear power. The result could be both a shift in capital and the launch of new and more effective funds.
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