In 1970, Walter Mischel, a professor of psychology at Stanford University, conducted a famous experiment now known as the ‘Stanford Marshmallow experiment’. Mischel offered children a choice between one immediate reward in the shape of a single marshmallow, or two marshmallows if they waited for a short period of time.

Some children were unable to contain their impatience and immediately ate the marshmallow. Others managed to withstand the pain of waiting by creating distractions such as talking to themselves, inventing games, and even trying to fall asleep (as one successfully did). In the end, the second group had their patience rewarded with the two marshmallows, says Seb Beloe, partner and head of research at WHEB Asset Management.

Last in, first out

It currently feels like a similar experiment is taking place in financial markets.  Only a few years ago asset managers were falling over themselves to tap into what were seen as lucrative markets for new ‘ESG’ and sustainability labelled investment funds. We called this the ‘ESG stampede’ as asset managers launched and rebranded existing funds. In 2020 alone, more than 250 European funds were rebadged as sustainable.

Since then, high interest rates have dampened returns for the mid-cap growth stocks many sustainability fund managers had focused on. ESG has also become a lightning rod for politicians keen to rile their base with the spectre of ‘woke capitalism’.  At the same time, regulators have begun to flex their muscles and demand higher regulatory standards for what constitutes sustainability. In doing so, they have increased compliance costs for fund providers.

Perhaps it is to be expected that the pain of waiting for future rewards is too much for many asset managers. Two years on from the ESG stampede, they are now frantically reversing out of this market. Data reported in late January showed that at least US$10bn had been withdrawn from ESG-focused funds in 2023. Another recent headline claimed ‘Groups slam brakes on sustainable fund name changes’ in response to slowing demand and higher regulatory costs.  A colleague attending a recent fund management conference reported that one very large fund manager has decided ‘not to bother’ to label any of their ESG-badged funds as sustainable under the FCA’s Sustainability Disclosure Requirements (SDR).

Avoiding the distractions

This is largely short-term noise. A large proportion of end investors want to invest in a way that generates a financial return while also supporting positive change in the world. The FCA’s Financial Lives survey, for example, found that 81% of adults surveyed would like the way their money is invested to do some good as well as provide a financial return.

The proportion that feels this way may well be diminished during a cost-of-living crisis. It is also likely to vary by gender and age. But research shows again and again that across all periods and in all groups a substantial proportion of those paying into pensions and savings products want to see a positive impact.

We also know the underlying issues people care about, such as inequality, climate change, ill-health and destruction of the natural environment, remain profound challenges for the world. Done well and with integrity, sustainability investing is part of the solution to these challenges. What is more, investors can benefit from the value created by companies in these growing markets.

Sorting the wheat from the chaff

Not everyone is being distracted by the current challenges facing the sustainability investment market. In contrast to many of our asset management peers, WHEB remains totally committed to sustainability impact investing. Not just because of the benefits it has on sustainability, but also because of the long-term growth potential for clients. Investors holding shares in companies that sell products and services that reduce greenhouse gas emissions or cure life-threatening diseases, themselves benefit from the growing markets for these types of products and services.

Like the children in the Stanford marshmallow experiment, the ambition and expectation is that sustainability investors will end up being rewarded with two ‘marshmallows’. A double dividend made up of good financial returns and a positive impact on the world around them.

By Seb Beloe, partner and head of research at WHEB Asset Management