MARKETS & INVESTING
Relative return of ex-energy indices vs the broad index , rebased to 100 at the start of 2020
Source : MSCI , Standard & Poor ’ s , J . P . Morgan Asset Management . Total returns shown in local currency . Past performance is not a reliable indicator of current and future results . Data as of 31 July 2023 .
In addition , companies that do not have good long-term growth opportunities or ESG scores can still generate good financial returns when profits are returned to shareholders or when there is a grab for yield , while factor rotations within the market are another element that can influence the short-term performance of sustainable strategies , many of which are often tilted more towards growth rather than value stocks .
The asymmetries in fixed income Ordinary shares do not have pre-defined time horizons , so for an equity investor the return depends on the payout prospects over the whole life of the asset . In contrast , a fixed income investor holding a bond to maturity is primarily concerned about receiving the agreed coupons and then having their principal returned over a fixed time horizon , creating an asymmetry . For example , consider a company that is on the right side of a new government announcement – for example , the producer of an alternative to single-use plastics after an announcement of a ban on single-use plastics . The stock investor sees a jump in the stock value , reflecting the enhanced outlook for long-term profits . A bond investor planning to hold the bond to maturity would not see an enhanced coupon or dividend , and so would not receive the same benefit from the announcement . Now consider the company that is on the wrong side of a government announcement , with the long-term viability of its current business model challenged . The stock investor loses out immediately . Whether the fixed income investor loses out over the lifetime of the bond depends on whether the coupons or principal are at risk . This risk would be expected to be greater on a longer-dated bond . Given this asymmetry , incorporating ESG risks in a fixed income portfolio might be expected to affect returns . Considering ESG issues can limit downside risk in a portfolio by capturing a broader range of potential sources of default risk . However , it could lead to underperformance if issuers who are riskier on the sustainability front do not default within the time horizon of the bond and therefore investors have forgone the higher spread that resulted from the pricing in of that risk .
Most importantly , history is unlikely to be a guide to the future Because the sustainability issues that we expect to drive markets are still in their infancy , even if it was possible to draw firm conclusions using historical index data , we would argue that history is unlikely to provide a useful guide to the future .
Nevertheless , there are four specific areas in which we believe ESG considerations have the potential to create market winners and losers : government policy , disclosures , consumer choices and central bank policy . Government policy is being encouraged by the demands of electorates . Clean energy stocks are often among the most exposed to new announcements given the direct impact that a shifting government stance can have on these companies ’ future growth and profitability . Yet as policy evolves to force markets to better reflect the externalities associated with climate change , the impact on company earnings is likely to be seen across all sectors . Increased disclosures , meanwhile , are helping to allow both consumers and investors to make more informed choices . Policy in this area is moving quickly , with central banks , regulators and governments increasing transparency around ESG risks by forcing companies to disclose more sustainability-related information about their businesses , from diversity statistics and pay of their employees to carbon emissions . In terms of consumer choices , attitudes and behaviours among consumers are changing rapidly , with potential consequences for the long-term profitability and market performance of companies . Areas where consumers are having a significant impact range from specific preferences ( such as the increasing rejection of single-use plastics ) to reputational risk from poor corporate ESG choices . And finally , while government policy is having a growing influence on the macro landscape , central banks are increasingly being asked to support these endeavours by ensuring that private capital forms part of the solution . Increasingly , central banks are having green targets added to their mandates . They can target these green mandates by using their regulatory levers to direct capital towards higher-scoring companies and by tailoring their balance sheet management to favour climate-friendly companies and sovereigns .
Conclusion We expect the ongoing shifts in government policy , regulation and consumer preferences to continue to change the macro landscape and consequently impact markets . We are also starting to see a shift in how exclusionary frameworks are being applied , taking into account transitioning companies and using climate scenario analysis to better assess whether issuers are ‘ fit for purpose ’. It is by being ahead of these developments in the coming years that we see the potential for investors to generate enhanced portfolio returns .
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