A narrative has taken root over the past few years that sustainable investment funds have had their time in the sun.
With growth so inextricably linked, many argue that sustainable investment cannot be successful in a world of high interest rates.
It is true that 2022 was a challenging year for sustainable investments as inflation soared and interest rates quickly had to catch up.
With growth style companies so much more sensitive to this high interest rate environment than value, it was inevitable that sustainable funds would suffer.
In the US, where the political situation makes things a little more nuanced, sustainable funds saw their worst ever quarter of flows in the first three months of this year, with $8.8bn (£6.7bn) being redeemed.
Despite this poor investor sentiment, it might surprise many to find out that sustainable funds had a very successful 2023.
Data from Morgan Stanley found sustainable funds outperformed their traditional peers across all major asset classes and regions in 2023, with sustainable equity funds in particular providing a median return of 16.7 per cent – more than two percentage points higher than traditional equity funds.
Interestingly, when investigating further, we found that sustainable investment funds, while inherently more volatile than a traditional equity fund due to their growth nature, have produced good risk-adjusted returns for the last three years to the end of April.
The key here is to be diversified.
Thematic funds, particularly those exposed to the energy transition alone, have struggled due to that challenging economic backdrop.
Ultimately, sustainable funds have been tarred by the same brush, perhaps unfairly, given how much focus is on security of the energy supply and decarbonising the economy.
Global sustainable funds reach far more themes than the energy transition, and while they have also benefitted from the US tech mega-cap outperformance, key contributors have also come from the healthcare space and industrials sector.
So, what will it take to shift some of those negative narratives into a focus on robust risk-adjusted performance?
Ultimately, the market is waiting with bated breath on that first interest rate cut from the Federal Reserve.
The Bank of England and European Central Bank look ready to pull the trigger on those cuts sooner, however these will likely have less of an impact than cuts coming from the US.
The market is pricing in one, maybe two, interest rate cuts this year.
As soon as we see that first cut happen, it is likely to provide a catalyst for both the sectors that have performed well of late, eg tech, and the laggards that rely so heavily on lower interest rates to help fund their projects, like renewable stocks.
While market expectations have a done a bit to boost performance in recent months, an actual cut will make a real difference. The performance gains at the end of 2023 are signs of what could come.
