Morgan Stanley
  • Thoughts on the Market
  • Dec 22, 2020

What’s in Store for ESG Investing?

Andrew Sheets and Jessica Alsford


Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley.

Jessica Aslford: And I'm Jessica Alsford, Head of the Global Sustainability Research Team.

Sheets: And on this special edition of the podcast, we are talking about the outlook for sustainability and ESG investing in 2021 and some key themes for investors to watch. It's Tuesday, December 22nd and 11:00 a.m. in New York.

Aslford: And 4:00 p.m. in London.

Sheets: So just let's take a look at 2021. What do you think is in store for ESG themes?

Aslford: So we would expect Decarbonization to still be one of the most investable themes of the year ahead. However, a lot of the more obvious pure play ways to get exposure to that theme have had a very strong 2020. And so instead, we're really arguing that you need to be a bit more selective and look for some of those underappreciated stories. We've also focused on sustainable consumption, both from the perspective of future food and sustainable packaging as well. And if you look at our recent Outlook piece, we highlight 15 stocks, so five from each of the regions of Americas, Europe and Asia, and 2/3 of those stocks or cyclicals. So really taking into account the fact that our strategists are overweight going into the New Year.

Sheets: And it's safe to say that this isn’t just a nice idea, there's a lot of real money flowing into these strategies, isn't there?

Aslford: Completely. And I've been in this space for over eight years now, and it's changed a huge amount over that time period. But what we've really seen over the last 18 months or so is this broadening of sustainable investing of ESG appealing to a much wider selection of investors and actually now equities, fixed income, long-only, long-short, systematic, active and passive. If you look specifically at ESG fund flows into the mutual fund market, you can really start to see the net inflows accelerating towards the end of 2019.

Aslford: Then 2020 came along and you had the pandemic and March you had outflows which completely understandable given the broader market conditions. There were some concerns. Then we were asked, is this the end of ESG? And we were very clear that we didn't think so. We thought actually it would lead to a strengthening of the sort of belief in the fundamentals of sustainability. And that indeed is what has happened. If you think about sort of average flows into those funds, the data base that we look at, you're talking around 20 to 25 billion dollars of monthly inflows. That then went up by over 50% in October and actually doubled by November. So a really strong end to 2020, and we think you'll see that continued momentum of flows into the year ahead.

Sheets: And Jess, so let's dig into some of those ESG themes that you've been focused on with your team. How do you see food interacting with the sustainability debate? And what do you think are the implications for markets and investors?

Aslford: The food debate and the future of food, the agri food system, I think, is probably one of the most complex areas, actually. You've got these competing challenges. So if we look out 30 years by 2050, the world needs to be producing 50% extra food to feed the 10 billion people that will be on this planet. At the same time, they need to change the distribution of food. We have two and a half billion people globally suffering from malnutrition. But not only do you have this, I guess, social aspect, but the agriculture and food industry together represent about a quarter of global greenhouse gas emissions. And if we are to achieve the Paris agreement and get to net zero greenhouse gas emissions by 2050, you really need to see some action being taken, new technologies being used, consumption habits changing.

Aslford: And solving for all of these different challenges is not easy. It's also a very fragmented industry. You're talking about millions of small farmers then feeding into a complex food industry and food value chain. So it's a huge task to undertake.

Sheets: Jessica. Europe has been a leader in the sustainable investing space. Where do you see Asia and the US in 2021?

Aslford: So both regions we're seeing really significant momentum. The US has been paying more and more attention over the last few years to sustainable investing. And is that the next stage of development, if you like, after Europe and then Asia a little bit further behind that. But I think why Europe has been the leader is partly demands from asset owners. But you've also seen the regulatory and the policy environment being very supportive for driving decarbonization of the economy, for supporting sustainable investing. In the US. President elect Biden has already made some signals that we ought to expect more policy that is supportive of halting climate change and encouraging sustainable investing. And for example, we would expect the US to sign back into the Paris agreement.

Aslford:  In Asia if you look at China, China has come out with their own net zero targets for 2060. And so, I think really important to see that policy support, which should act as a catalyst for driving further sustainable investing in those regions.

Sheets: Taking a step back. I'd be curious how you think the pandemic and the focus on racial equality this year. Two of this year's bigger stories, how they've changed how investors are thinking about about ESG investing?

Aslford: Yeah, it's a good question. And for some time, I think the environmental aspects of ESG and sustainability have really been dominant, I think partly because there's just more data. So the social side has been much more difficult. But as you say, two really important events this year which has put the social part of ESG back in front of people's minds. And I think this is in a couple of particular ways. As far as the pandemic is concerned, back in March, April, we made the argument that how companies respond to the pandemic and how they treat all of their stakeholders is going to have long lasting implications, whether that be reputational risk, whether it be about being an employer of choice going forward, whether it's about supply as having sort of long lasting memories, I guess, about how they were treated during these difficult times.

Aslford: And so we have definitely seen investors tracking how companies have behaved and making sure that one group of stakeholders, including investors, aren't being prioritized above all others. From the racial inequality side, diversity is not a new topic, but again, partly because of data issues. I think diversity has always been really looked at from a gender perspective. And I think, again, the events of 2020 has just made it much more pertinent about just how important race and ethnicity is. And so we expect investors to be engaging with corporates much more to really make sure and hold corporates accountable for what they're doing to try and drive diversity and inclusion across the range of different definitions.

Sheets: So we mentioned earlier about these very large inflows that are happening into the ESG space. I mean, it's probably one of the biggest areas of growth that that asset managers are seeing, one of the greatest areas of demand from investors.

Sheets: But I think there's also a certain level of skepticism and cynicism towards the space that, you know, ESG is kind of a nice thing to have, but at the end of the day, you invest to make the highest return possible, and that's what one should be doing. And you don't have the luxury maybe of looking at some of these other factors. So what would you say to those cynics? How do you think about the return potential in ESG and why how do you see that relating to kind of the inflows story that we've been seeing?

Aslford: So there are lots of examples how sustainable investing makes attractive returns. One example of this might be if we look at Europe again, back in May, the EU announced its recovery fund and that at least 30% of that fund would be designated towards green activities. Now, a group of stocks which we have highlighted as been positively exposed to that theme, have since outperformed the broader market by around 30%. And actually, you can see lots of examples of of stocks, which are a very clear way to play that positive sustainability angle across the globe that have very strong performance.

Sheets: Jess, thanks for taking the time to talk.

Aslford: Great speaking with you today.

Sheets: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people find the show. 

On this special edition of the podcast, we discuss the outlook for sustainability and ESG investing in 2021 with some key themes for investors to watch.

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