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“Perfect storm” hits ESG shares, but here’s why you should keep investing

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2022 is shaping up as a rough year for ESG investors, but the pain could be short lived.

A near perfect storm hit ESG investors, but the long-term trend for these investments is only accelerating, an industry expert reveals.

Environmental, social, governance (ESG) investing was one of the hottest trends in 2021.

But according to Janus Henderson's head of global sustainable equities Hamish Chamberlayne, a changing macro environment has put pressure on these investments.

"The Russia/Ukraine conflict, rising inflation, slowing growth, central bank activity, and the lingering impact of the pandemic have created much uncertainty at a macroeconomic level," Chamberlayne said.

This is at the same time the market is changing its investment approach towards value shares.

"This has combined with a shift in market rhetoric to a strong anti-growth and less positive ESG stance leading to stronger performance from sectors typically not associated with sustainable investing, such as energy, defence, tobacco and commodities," he continues.

So why should you keep buying?

ESG was nearing bubble territory

While the price is currently dropping in 2022, it could actually be a positive for the sector.

According to Chamberlayne the market was forgetting the fundamentals and focusing on potential long-term gains.

"Appetite reached peak levels for these 'story' stocks, with the promise of what's to come in the future trumping cash flows and profitability today."

This was leading to exaggerations in asset prices.

"Investors were sold on growth stories, with record low rates seeing free cash almost to the point where ESG was becoming a bubble."

However, these pull-backs are making the market shift back towards normality.

Long-term outlook remains bullish

Despite a difficult 2022, Chamberlayne points out it is important for investors to separate short, medium and long term performance.

He points out that the challenges of the last 2 years are seeing governments increasing their focus on making investments in renewable energy and helping to re-shore and localise supply chains.

But he urges investors to look at business fundamentals over promises of a brighter future.

"This emphasises the importance of focusing on the true health of companies today as opposed to the 'stories' of tomorrow.

"The short-term challenges for ESG investing have been meaningful, but, in our view, the longer-term direction of travel is unchanged," Chamberlayne said.

And Australia's largest businesses are becoming more ESG focused

The changing sentiment around ESG investing is continuing with Australia's biggest companies.

Almost 3 in 4 top 200 companies listed on the Australian Securities Exchange now give detailed or comprehensive information about their ESG footprints, with ESG investing becoming a norm for the Australian market.

The Australian Council of Superannuation Investors (ACSI) says 64% of the ASX200 now map their risk against individual UN sustainable development goals, with climate action being the most cited.

Louise Davidson, ACSI CEO says over the years, the quality and detail of reporting on material ESG issues has progressively risen. Now, providing investors with ESG disclosures is the norm rather than the exception.

"The rise in reporting signals that corporate Australia now recognises that managing material ESG risks is a crucial part of doing business," Ms Davidson said.

But 6% of companies are not disclosing their ESG risk.

"While not all ESG risks are relevant to all companies, every company faces some ESG risks, and they should be reported," Ms Davidson said. "If a company does not report, it is not possible for investors to assess whether a company is aware of its ESG risk, let alone how a company is managing its risk."

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