James Ragan, CFA, Senior Vice President, Co-Chief Investment Officer, Director of Investment Management & Research
Following a surge in environmental, social, and governance (ESG) fund investments during and after the 2020-2021 pandemic, fund flows turned modestly negative in 2023 and 2024.1 Despite some investor attrition, total dollars invested in these funds increased more than 6 percent in 20242 due to market appreciation, and invested dollars remained significantly above pre-pandemic levels.
The two-year cooling of enthusiasm for ESG could be attributed to several factors, including very strong market gains led by technology-centric growth stocks that have attracted a large percentage of investor assets. But we also consider emerging anti-ESG sentiment in the U.S., reflected in investor groups pushing back on state ESG mandates imposed on public retirement plan assets, and other investor groups introducing anti-ESG proposals at annual shareholder meetings, arguing that some ESG initiatives could harm shareholder returns. One result of these challenges is that companies will work to defend and/or improve their policies, which can elevate ESG support through disclosure and transparency. ESG investing, while not important to every investor, remains an important asset class for investors who want companies to elevate socially responsible outcomes, along with maximizing shareholder value.
Below, we highlight key ESG topics to consider in 2025, as an evolving environment introduces new factors for investors looking to align values with investments.
A New Administration
The early weeks of the Trump administration have already seen policy changes on energy transition, climate change, and human resources. This includes the revocation of a Biden-era executive order that aimed to make half of all new vehicles sold in 2030 electric vehicles, the withdrawal from the 2015 Paris Climate Agreement, and an order calling for the end of private sector diversity, equity, and inclusion hiring programs, among others.
While it is too soon to know the impact of these changes, the new administration’s positioning thus far indicates a shift away from mandating that corporations follow ESG-related guidelines. This, in our view, leads to the potential for diverging corporate practices in the absence of mandates, creating opportunity for companies to set independent goals and metrics. While some would argue this delays progress on important sustainability issues, companies can still actively align operations with the values of ESG stakeholders if they so choose. Investors deploying socially responsible allocations may need to become more actively aware of ESG characteristics of portfolio holdings and pay more attention to how companies are prioritizing their ESG policies.
Generative AI and Its Demand on Energy Infrastructure
One of the most discussed advancements in 2024 was the rise of generative artificial intelligence (GenAI). Early in 2025, the Trump administration expressed support for capital investments in infrastructure to build GenAI technology, including expanding data center capacity. This investment will require substantial increases in reliable power generation. With a need for more electricity, policies to expand production from all sources of energy are increasingly under discussion. These are likely to include an “all of the above” strategy that balances renewable and fossil-fuel based sources.
Given the subjective value of individual ESG components, sustainability-aware investors should consider the cost of progress when aligning their ESG criteria with their investments. Reevaluating the importance of each ESG component gives investors the power to actively prioritize key issues represented in their portfolios, with these priorities evolving over time.
Changes in ESG Disclosure Mandates
This year, the European Union (EU) will begin requiring EU companies and non-EU companies subject to the Corporate Sustainability Reporting Directive to publish reports following the European Sustainability Reporting Standards, which cover a set of 12 thematic standards on a range of sustainability issues. Most notably included in the requirements is the concept of “double materiality,” which will require companies to disclose how their actions impact the environment and society, as well as how sustainability issues and risks affect their business and financial performance.
Outside of the EU, an Australian law passed in September 2024 will add climate-related disclosures to annual reports for certain companies for fiscal years starting after January 1, 2025. The UK is set to make decisions on the adoption of standards set by the International Sustainability Standards Board, with publication of those standards expected in the first quarter of 2025. Other significant regions, including Hong Kong and Singapore, are also weighing disclosure mandates moving forward.
Trends in sustainability disclosure are important to watch as increased disclosures can provide investors with additional information to make comparisons and base decisions. This, however, will need to be balanced with the cost of providing such disclosures, and investors should consider what information is relevant when making decisions on sustainability.
While change can build uncertainty, it also creates opportunity for companies to lead and excel in an evolving landscape. We believe that ESG values, when developed organically, open opportunities for companies to express their corporate ESG goals. While this likely creates more work for companies, as they must articulate how these goals drive shareholder value, in our view it is positive for investors who want socially aware alternatives in their asset allocation models. Rather than follow a one-size-fits-all template, ESG analysis can follow a more natural process.
D.A. Davidson is committed to providing portfolio solutions for clients who want to improve the ESG rating of their portfolio. For more information, contact a D.A. Davidson financial professional.
1 Morningstar’s U.S. Sustainable Funds Landscape 2024 in Review
2 Morningstar’s U.S. Sustainable Funds Landscape 2024 in Review
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