Sustainable Investing: Navigating Style Biases for Long-Term Gains

Guilherme Pampolin, Investment Research Associate, Square Mile Investment Consulting & Research

Note: The views expressed on these pages are the opinions of their respective author(s) only and do not necessarily reflect the views and opinions of UKSIF.

This website should not be taken as financial or investment advice or seen as an endorsement or recommendation of any particular company, investment or individual. While we have sought to ensure information on this site is correct, we do not accept liability for any errors.

Sustainable Investing: Navigating Style Biases for Long-Term Gains

Guilherme Pampolin, Investment Research Associate, Square Mile Investment Consulting & Research

Much has changed over the past five to six years. Five years ago, Bayern Munich were the winners of the UEFA Champions League, Boris Johnson was the Prime Minister of the UK, Lewis Capaldi was topping the UK charts and Avengers: Endgame was a must-watch in the cinemas. Oh, and yes –sustainable investment was extremely popular and mostly profitable…

Since then, or more precisely, since 2021, the landscape has become somewhat more complex for responsible investors. However, importantly, this is not related to sustainability as a concept.

Sustainability is rooted in newly accepted norms and long-term megatrends, such as transition to a low-carbon economy, an ageing population, better water & waste management and focussed health & wellbeing. Mutual funds, however, have their own investment styles favouring certain characteristics of securities, potential exclusions and sectoral biases. This implies that the underperformance of many funds in recent years has more to do with their investment style, sector tilts and biases than with the sustainability narrative.

When we look back to the 1990s, growth stocks significantly outperformed value due to the dot-com boom, while quality lagged but still provided positive returns. In the decade following the tech bubble collapse and the financial crisis, it was time for value to outperform growth, when quality was also a strong and relatively safe heaven. It emphasises that, just as different investing styles cycle in and out of vogue, so too we are seeing a period where the style of many sustainable funds faces headwinds.

Sustainable equities are typically associated with a growth style bias, with specific sector tilts, meaning that tailwinds and headwinds will affect these portfolios in a particular way, which will differ from the broader market. This growth bias is frequently a consequence of an emphasis on innovative technologies aimed at addressing environmental and/or social challenges. Lower interest rates, technological innovation and regulatory support are some of the significant drivers that tend to favour these kinds of investments. The polar opposites are more likely to cause problems.

Meanwhile, the importance of long-term megatrends should not be underestimated. To give some examples, the adoption of electric vehicles, innovations in the healthcare sector, and the need to properly manage our waste cannot be stopped, just as the adoption of smartphones or the discovery of certain medicines and medical devices could not be suppressed years ago.

It is true, however, that the adoption of these technologies resulted in unambiguous winners and losers. On one side, we have Apple, Samsung, Pfizer, and Johnson & Johnson, to mention a few. On the other, we have BlackBerry (remember them?), Nokia, ProSomnus, and Nuvectra. The dynamic is similar in the context of sustainable investing. Strong fundamentals, truly innovative ideas with high barriers to entry, long-term competitive advantages, and effective management are frequently key drivers of success.

It means that, while most of us will agree that the themes found in the sustainable world are extremely exciting and unstoppable, there will be distinct winners and losers, just as there are with any revolution. And that is why stock selection based on thorough fundamental analysis is so vital.

Opportunities won’t necessarily grow on trees. However, given the challenges experienced by the sector in recent years, some valuations seem strongly depressed, making the risk-reward ratio appealing to long-term investors. As a matter of fact, there’s been a recent trend of private equity firms acquiring public sustainable companies, notably in the renewable energy sector. This is due to a mix of long-term investment horizons, value creation opportunities and the appealing growth prospects stemming from the clean energy transition.

In reality, while not wanting to over-focus on clean energy specifically, data also support the narrative in favour of this long-term trend. According to BloombergNEF and the International Energy Agency (IEA), the global clean energy investment in 2024 reached a record $2.1 trillion, more than doubling from 2020. China alone accounted for two-thirds of the entire global increase, followed by the EU and the United States. Another interesting piece of data came from the Confederation of British Industry, reporting that the so-called green economy is growing three times faster than the overall economy, which has led to the creation of high-wage jobs, reduction of emissions and favouring energy security.

The point that I’m making here is that the increasing urgency for climate action and to address social challenges, along with the growing economic attractiveness of sustainable solutions is expected to drive long-term growth in sustainable products, regardless of the political environment. The recent underperformance of such investments is mostly linked to the biases and restrictions (e.g., exclusion of certain sectors like fossil fuels or defence) that sustainable propositions have in place as well as underlying stock-picking decisions rather than linked to the sustainable investment theme as whole.

Style biases often generate return profiles that resemble a pendulum – years of underperformance followed by years of overperformance and vice-versa. There is a natural market rotation. Nonetheless, the right funds can still be included in a diversified portfolio if it is suitable to clients’ profiles.

Considering the temporary drop in interest for sustainability products and increased focus on a reduced number of stocks across the markets, it is worth remembering the words of Warren Buffett: “be fearful when others are greedy and greedy only when others are fearful”.

Note: The views expressed on these pages are the opinions of their respective author(s) only and do not necessarily reflect the views and opinions of UKSIF.

This website should not be taken as financial or investment advice or seen as an endorsement or recommendation of any particular company, investment or individual. While we have sought to ensure information on this site is correct, we do not accept liability for any errors.