Sustainable investing: Green shoots and leaves

Sustainable investing has had a sobering few years. For many investors, an initial foray into ESG integrated or sustainable focused funds coincided with Covid, then rising interest rates, and a sharp reversal in market leadership. The relationship between avoiding harm and doing good was initially compromised and until recently, appeared to be broken down altogether. It was never enough to simply be aspirational. Performance matters.  

At the same time, the broader narrative around sustainability has become deeply polarised. Carbon reduction and climate change, for example, has been hijacked on the left by eco-zealots and on the right by climate deniers. In the US, the current administration has been vocally hostile to ESG, adding another layer of uncertainty for fund managers and investors alike.

Undoubtedly any issue that matures into public consciousness becomes subject to political influences. It needn’t be a bad thing. Although many investors have been left somewhat disillusioned by the extreme tones.

See also: Biodiversity: A theme of growing importance and investment opportunity

We’ve seen the types of companies that the more impact focused funds invest in, for example healthcare, mid caps and quality growth style, falling out of favour from 2022. Momentum and US-centric large caps have ruled the roost. All of a sudden, the market has developed a sense of FOMO and the longer-time horizons many sustainable investments require have been disregarded.

The effects have been dramatic, many sustainable fund managers have seen reductions in ESG headcount, there have been high-profile sustainable fund closures and the entire sector (bar a handful of funds) has seen considerable outflows.

Sustainable fund underperformance in recent years has been exacerbated by the narrow leadership of global equities, with returns dominated by a small number of large technology stocks. However, focusing solely on recent disappointment risks missing the early signs of a recovery that is already under way.

There are performance green shoots. In 2025, the MSCI Alternative Energy index rose by 33% in sterling terms, comfortably ahead of the MSCI World’s 13% gain. This was underpinned by improving fundamentals, order books and policy uncertainty easing in key markets.

For example, shares in wind and selected solar companies have rebounded as earnings have stabilised (see Vestas and SolarEdge chart below). Two funds we rate in this space, Guinness Sustainable Energy and Schroders Alternative Energy returned 18% and 29% respectively in 2025. It is also pleasing to see global sustainable funds with both value and growth exposures improving. There have also been some credible returns in funds with thematics around water usage and the circular economy.

Interest rates have also become less of a headwind. Sustainable assets, particularly those linked to infrastructure and long dated cashflows, are inherently sensitive to the cost of capital. The shift from rising to falling rates has materially improved the backdrop. I don’t see a return to environment of the early 2020s, but it does restore some balance between growth and discounting, which is essential for capital intensive sectors such as renewables, grids and storage.

Crucially, long term institutional investors have not meaningfully changed course. Pension funds and endowments remain keenly focussed on social and environmental issues. I was recently involved with a pitch with a charity for whom sustainability disclosures were materially important. Focus has shifted slightly away from labels and exclusions towards resilience, energy security and long-run cash generation, but the underlying commitment appears intact.

On the industrial side, cost curves continue to move in the right direction. Batteries manufactured in China are becoming cheaper year after year and are now being deployed at scale in important markets such as Brazil. This is key for improving grid stability and project economics at the same time.

Valuations are another underappreciated support. Many sectors deemed “sustainable” still trade at a discount to the broader market, despite having beaten earnings expectations more recently. This disconnect reflects lingering scepticism and fatigue rather than deteriorating fundamentals. In several cases, earnings growth expectations now exceed those of the MSCI World, yet price to earnings multiples remain lower. That combination is unlikely to persist indefinitely. When healthcare companies and mid-cap stocks bounce back, things will look considerably more buoyant.

See also: Why investors should stay the course with sustainable energy

These developments point to a more grounded phase for sustainable investing. The hot money has left the building. Expectations are lower, valuations are more realistic and the focus has shifted from virtue signalling to investor returns. Regulation and policy developments too remain a robust tailwind.  

For investors willing to stick to the longer-term time horizon, the fundamentals are not only improving, but I believe, compelling. Performance has begun to recover, capital costs are easing, long term capital is staying put and the thesis of themes such as the energy transition is becoming harder to ignore. There is a path to redemption.