ESG: Progress and clarity signal investment opportunities in 2024

We see meaningful change in the ESG landscape in 2024. Here, we explain the three themes dominating our thinking and why they are important considerations for investors.

Enabling the transition to a sustainable economy

The scale of global environmental challenges we face is unprecedented. Governments are trying to mitigate emissions, build resilience through climate adaptation, and enact policies to address other sustainability challenges.

The speed of progress will inevitably depend on the vagaries of politics. Next year sees elections for the next US president, UK prime minister, India’s government and parliament, and European Parliament members that will shape the path of ESG regulations, and commitments on climate goals. We have written before that governments must lead on climate action, while also providing incentives for companies and investors to help attract private capital.

A successful transition to a sustainable economy offers investors the chance to facilitate and accelerate the speed of the transition, through three distinct investment opportunities:

Solution providers/innovators – Companies that are leading the sustainable transition through their products and services to accelerate the move to a low carbon and circular economy, such as clean energy, clean tech, energy efficiency, waste management, sustainable transport, and heat pumps.

Enablers – Companies accelerating and enabling the transition through their products and services. They may not be low carbon themselves but are essential for decarbonisation, including transition metals for the “electrification of everything,” and pipelines to prepare for hydrogen, water, and waste management upgrades.

Improvers – Companies in high emissions sectors whose activity underpins the economy today and tomorrow, and whose transition is critical. These include progressive oil majors, and those in the cement and steel, aviation, and agriculture sectors that are generally have high carbon intensity businesses but are significantly improving their operations to move to a sustainable business model.

Investors are also beginning to think about tackling nature loss. In September 2023, the Taskforce on Nature-related Financial Disclosures (TNFD) published its finalised framework that will allow companies and financial institutions to assess their dependencies and impacts on nature, just as the Taskforce on Climate-Related Financial Disclosures (TCFD) has done for climate change. We believe the transition to a nature-positive¹ world will accelerate in 2024.

As a TNFD Forum Member, Janus Henderson has followed the evolution of the framework closely. We have also joined Nature Action 100+ to engage with companies on financially-material issues related to nature loss.

Social factors come to the fore

Sustainability challenges can only be tackled – and solutions only be sustained – through addressing societal impacts and dependencies. A Just Transition² should explicitly consider the people enabling the transition, and the impacts of the transition on workers, particularly in high-emissions sectors and those in emerging markets most exposed to climate impacts.  A transition that fails to account for these social impacts and dependencies can create risks for people, companies, and even entire regions, as well as potentially negatively impacting cashflows and valuations. So, enabling a Just Transition is not just the “right thing to do”; in the long run, it is also a financially smart move.

Governments should lead on the Just Transition, and both the EU’s Green Deal and the US Inflation Reduction Act prioritise the Just Transition. However, the private sector must also play a key role in not only providing the necessary capital and investment, but also proactively addressing social issues in their strategy, operations, and supply chain.

Yet, a recent study showed that the overwhelming majority of companies targeted by Climate Action (CA) 100+³ are failing to meet expectations on the Just Transition.⁴ There is a goal for 50% of CA 100+ companies to make a Just Transition commitment before the next Net Zero Company Benchmark is released. Among the key indicators that are tracked by CA100+ are human capital, human rights, health and safety, training, and social dialogue. Companies that are managing the needs of all their stakeholders are mitigating risk, and better placed for success, therefore, enhancing the prospect for long-term economic value creation.

Human rights is another focus area. The forthcoming European Parliament Directive on Corporate Sustainability Due Diligence (CSDDD) will require large companies, and potentially financial institutions, to undertake due diligence (not just disclosure) on their own activities and that of their suppliers. Institutions will have to identify and prevent, end, or mitigate any actual or potential adverse impacts of their activities on human rights and on the environment. We expect this will be a significant challenge for many companies, particularly those with complex or long supply chains.

Labour and human rights will also be key considerations for companies and investors when evaluating nature-related impacts and dependencies. According to the new TNFD framework, “Meaningful engagement with indigenous peoples and local communities is a critical part of any organisation’s identification and assessment of nature-related issues.” This is because although they comprise less than 5% of the world population, indigenous peoples protect 80% of the Earth’s biodiversity.

At Janus Henderson, we believe consideration of a company’s financially material social issues represents good risk management and can unlock investment opportunities amid an evolving regulatory and policy backdrop. We engage companies on a range of material social issues and metrics, including human rights, human capital, diversity, equity and inclusion, and access to medicine. Further information and engagement case studies can be found in our 2023 ESG Company Engagement and Voting Review.

The end of greenwashing?

Corporate and investor commitments on key ESG issues need to be genuine and credible, something regulators and broader market participants are acutely aware of. Amid a flurry of bold green claims from companies and financial institutions in recent years, there has been a welcome regulatory focus on greenwashing, which will increase in 2024.⁵

To meet its net zero emissions goal by 2050, the European Union has introduced a Taxonomy, defining criteria on ‘sustainable’ activities, which is also used by companies in Sustainable Finance Disclosure Regulation SFDR reporting. In 2024, the EU will expand the sectors and activities covered by the Taxonomy, affecting corporate and investment management disclosures.⁶ The Corporate Sustainability Reporting Directive (CSRD) regulations, which come into force on 1 January 2024 in Europe, will require companies to report comprehensively on their ESG impacts.⁷

Meanwhile, asset managers may be subject to European Securities and Markets Authority (ESMA) guidelines, where there are plans to impose strict criteria on the use of the term “sustainable” in fund names, defining a minimum percentage of “ESG” and “sustainable” investments.⁸

Outside of regulation, the CFA Institute, the Global Sustainable Investment Alliance (GSIA) and the Principles for Responsible Investment (PRI) have also set out harmonised definitions for five widely-used responsible investment terms in a bid to improve communication.⁹ The focus will be clearly differentiating the objectives of approaches, including ESG integration, impact investing, and screening.

We expect those companies that show genuine leadership on ESG issues to be increasingly differentiated and have a premium, as regulations become more stringent and management of ESG issues becomes a key criterion for financial decision makers.

In contrast, those institutions that pay lip service to material ESG issues could increasingly face reputational risks, falling consumer demand, or even litigation. Indeed, this is already happening. In September 2023, investment firm DWS agreed to pay a US$19 million fine to the US Securities and Exchange Commission, in part for “materially misleading statements ” regarding its ESG investment process.¹⁰

At Janus Henderson, we believe the increased scrutiny on institutions’ ESG claims is much needed. Emerging greenwashing rules and regulations will enable customers and clients to better differentiate between genuine and overblown ESG claims.

The road ahead

Our three themes will bring greater clarity for ESG investors in 2024. They also represent exciting opportunities for investors who want to benefit from integrating material ESG factors into their investment process, and from investing in specific themes aligned to the transition to a sustainable economy.

IMPORTANT INFORMATION

Sustainable or Environmental, Social and Governance (ESG) investing considers factors beyond traditional financial analysis. This may limit available investments and cause performance and exposures to differ from, and potentially be more concentrated in certain areas than the broader market.