The Ethical Investor: 4 big picture thematics that will define ESG investing in 2024 and beyond

The year 2024 will be an important one for ESG investors.

It’s the year when sustainable investment opportunities are likely to branch out from listed markets, to other areas such as private equity.

Investors should also expect growing interest in themes beyond climate, and this could include nature and biodiversity, as well as social issues.

Artificial intelligence, racial, and gender themes, along with access to affordable housing, healthcare and education could also be some of the hot thematics in 2024.

Experts at the responsible investment manager, Federated Hermes, have come up with a list of thematics they believe could shape the ESG investing world over the next 12 months.

Renewable energy not ‘a nice to have, but a must’

Sentiment towards renewable energy has been overly negative over the past 12 months.

This has been driven by perception that renewable projects no longer offer attractive returns due to the higher cost of capital – caused by higher rates and inflation.

The negative sentiment was exacerbated recently by Orsted, a Danish wind company, which cancelled two offshore wind projects in the US and took a US$4 billion write-down due to escalating costs and higher interest rates.

This was followed by BP cancelling two of its US offshore projects at a cost of US$540 million, citing similar reasons.

But according to Ingrid Kukuljan, Head of Impact and Sustainable Investing at Federated Hermes, these short-term headwinds should not take the focus away from the issues we need to address to ensure sustainable living conditions for our planet.

“It is becoming a reality that we are unlikely to reach the Paris Climate targets. However, if we are to get at least close to 1.5 degrees, we need to considerably amp up spending on clean and renewable energy,” Kukuljan said.

The energy transition, she believes, is still in the early stages and the demand for renewables remains elevated as they account for less than 30% of the total global energy generation.

‘The path to renewable energy is not a nice to have, but a must, which means the sector is poised to grow over the long-term, despite the short-term headwinds.’

“This will be supported by regulatory tailwinds such as EU Green Deal and Inflation Reduction Act in the U.S.. As such we consider renewables as one of the most attractive investment opportunities for the long-term.”

The outlook in 2024 for renewables is therefore promising, as the world continues to prioritise sustainable solutions in response to environmental challenges.

“Solar energy, in particular, is witnessing significant advancements as innovations in photovoltaic technology are driving increased efficiency and affordability of solar panels.

“Wind energy is undergoing a transformation with the development of more efficient turbines.

“We are hoping to see more government policies and incentives post COP28 and expect, in 2024, global commitment to clean energy to strengthen, as countries are expected to implement ambitious renewable energy targets and carbon reduction goals.”

Growing concerns of Artificial Intelligence safety

Artificial intelligence (AI) is fast becoming one of the most important themes in investment.

While AI has the potential to drive a 4th Industrial Revolution and is creating unprecedented new opportunities for businesses, it introduces new ethical dilemmas and risks.

Bruce Duguid, Head of Stewardship, EOS at Federated Hermes, says the need for ethical AI was highlighted earlier in the year when over 1,000 researchers and executives called for a halt to what they described as a ‘dangerous’ arms race in AI development.

More recently, an inaugural global AI Safety Summit, hosted by the UK at Bletchley Park, sought to address the risks posed by frontier AI.

“The potential risks of AI are well documented and include misinformation, unintended bias, a lack of transparency or explainability, and disruption of the workforce,” said Duguid.

‘The urgency to address these concerns has led to a global, yet fragmented, race towards new regulation – from the EU’s AI Act to China’s Generative AI Regulation.’

In 2024, as AI deployment accelerates, Duguid expects the importance of strong AI governance to become more apparent.

“In 2023, companies began to face industrial and legal action over issues ranging from workforce disruption to unintended bias and misinformation. In 2024 this trend is likely to continue, given the increasing number of use cases for AI.

“We expect that, while governments will seek to establish common ground on regulation, regional differences will persist, given conflicting priorities regarding innovation and end-user protection.

“This will make it essential for companies that operate internationally to adhere to high standards of AI ethics, and self-regulate in a manner that can mitigate risk across multiple jurisdictions,” said Duguid.

Earth’s natural capital is heading in ‘wrong direction’

On August 2nd, 2023, the planet hit Earth Overshoot Day.

This is the day each year that the planet consumes its annual budget of natural capital required to generate economic value to humanity in that year.

Beyond Earth Overshoot Day, the planet eats into the following year’s budget of natural capital. As such, from Earth Overshoot Day we are running natural capital budgets.

When scientists first calculated Earth Overshoot Day in the 1970s, it occurred in late December; 10 years ago it occurred in late August.

The trend is moving in the wrong direction.

Moreover, scientists at the Stockholm Resilience Centre (SRC) have estimated Earth is now operating outside of six of its nine Planetary Boundaries.

The SRC believes that planet must remain inside of these nine boundaries to remain stable and provide for the growing population.

“If there ever were a red flag on the weakening ability of the planet to provide for humanity in perpetuity, this is it,” said Mitch Reznick, Head of Sustainable Fixed Income at Federated Hermes.

“Why does this all matter? According to the World Economic Forum, over half of global GDP “is moderately or highly dependent on nature and its services,” said Reznick.

“With natural capital under threat, so then is the generation of global economic value. This is, therefore, a systemic risk.”

Fortunately, Reznick says that a myriad of international organisations, countries, regulators, companies, and investors recognise this, and are responding.

“This global pushback on the planetary effects of the Anthropocene Age generates forces that lean into sustainability – changes in regulations; shifting value changes and evolving consume preferences.

“These forces are triggering systematic changes in the economy and, consequently, finance,” he said.

Reznick added that companies that have the visibility and the governance to see these structural changes and adapt to them, are the resilient companies of the future.

“They are the winners through this irrevocable change in the economy.

“As we look ahead to 2024, valuation permitting, these are the companies that we seek to direct debt investments, because we believe they will be sources of alpha for our clients, and positive impact for the environment and, therefore, society,” said Reznick.

Regulations will be key

Meanwhile, Gemma Corrigan, Head of Policy and Advocacy at Federated Hermes also believes these natural capital themes will continue to rise on the agenda in 2024.

“To date, we have largely taken nature and its permanence for granted – but as we reach critical and irreversible tipping points, there will be limits to growth and the potential for huge financial losses if we continue on our current trajectory,” she said.

The good news is that we still have an opportunity to fix this problem.

“Countries will be expected to deliver national biodiversity strategies, and we will be pushing governments to deliver on both their 30% by 2030 goals, and the more detailed targets outlined by the Global Biodiversity Framework.

“This means protecting the most important biodiversity hotspots, reorienting subsidies to reward nature friendly activities, and tackling the main drivers of biodiversity loss,” Corrigan said.

Political will also needs to be translated into clear, effective and fair policies, she says, with governance systems that protect tropical forests and oceans and other critical ecosystems.

‘Existing companies should consider how they are impacting and dependent on nature, and how they can restore the subsequent damage.’

“We need to move our collective focus from risk mitigation to nature positive, by developing new regenerative and circular business models and revenue streams.”

According to Corrigan, there are already lots of innovative companies developing solutions, and we need equally innovative financing solutions.

“Blended finance will be key to delivering the outcomes we want to see in the most precious ecosystems, particularly in the global south where financing must be scaled significantly.”

And with mandatory climate disclosures increasingly widespread, regulators will soon turn their attention to nature-related disclosures.

“Disclosure is not the end in itself. As data availability improves, regulations are emerging that are pushing corporates and financial institutions towards concrete action,” said Corrigan.

“In the EU, for example, 2024 will see the agreement of the Corporate Sustainability Due Diligence Directive to require corporates and potentially also financial institutions to take action to identify and mitigate social and environmental adverse impacts in their value chains.”

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