Sustainable investing, which means paying keen attention to Environmental, Social and Governance (ESG) considerations when picking stocks, is gaining in popularity.
That’s no surprise as the Covid-19 crisis has brought the potential of a fossil fuel-free world into view. The prices of oil and energy stocks have slumped. Some governments are taking the chance to forge a green recovery. ESG investing is being taken seriously by large and small investors, and this will change the way stocks are priced. Top UK green stocks, in my view, have the potential to outperform their peers.
So I think UK investors will need to add top UK green stocks to their portfolios or select green funds to have a chance at getting the best long-term returns.
Winds of Change
When you think of the Gulf states, hydrocarbons might come to mind. But it might be surprising to learn that a Saudi electricity company and Qatar National Bank have recently sold green bonds to raise finance for environmentally-friendly projects. Investors gobbled up these bonds. And hedge funds are reporting that their institutional clients are demanding strategies that target ESG goals too.
A lot of the pressure coming from institutional clients — pension funds are good examples — might be driven by upcoming regulations requiring them to perform enhanced ESG disclosures. A pension fund will need its asset managers to do so, and they’ll need the companies they invest in to do the same.
Soon, the financial reports of companies will explain how good, or bad, they perform on ESG issues in detail. The bad performers will face scrutiny and be ignored by sustainable investors. As a result, their share prices may come under pressure. Top UK green stocks should do well instead.
UK green stock gains
Some investors won’t care if a stock performs well on ESG issues or not. All that matters to them are the returns. They might have to consider ESG issues nonetheless, simply as predictors of return.
Let’s look at an example. The London Stock Exchange‘s Green Economy Mark is issued to firms that get 50% or more of their revenues from green sources. The FTSE All-Share index contains 45 of these Green Economy Mark companies. The price of this index fell to 2,728 in March as stock markets crashed. It closed at 3,287 on 23 September, which is an impressive 20% price rise. But the market-capitalisation return of a portfolio of just the 45 Green Economy Mark stocks would have returned 32% over the same period.
An ESG themed subset of the FTSE All-Share outperformed the broader index from March through September 2020. So any investor who has no ethical stance on ESG issues might want to consider them simply because of their profit potential.
So my message to Fool UK readers is that you should be paying attention to ESG issues when you pick stocks or funds. I think sustainable investing isn’t only attractive ethically but will offer better returns in the long run.
So which sustainable would I buy? Well, I’ve written before about what I think are three top UK green stocks. Kingspan, Smurfit Kappa, and Oxford Instruments are Green Mark stocks that have returned 74%, 53% and 60% respectively since March’s stock market crash. And Impax Environmental Markets is a Green Mark fund with an impressive 41% post-crash return. It really is easy being green!
James J. McCombie has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.