Bank of America Merrill Lynch (BofAML) estimates that assets under management in ESG equity funds based in Europe will rise by €1trn by 2030.
In its paper entitled ESG Matters - Europe: Great for the world, good for returns, BofAML analysts predict ESG investing in EU equities will rise by €800m-€1.1bn by the end of the decade, with one in three funds to be focused on ESG investing.
Over the last two years, flows into ESG funds have gone up eight-fold, while the number of ESG funds available in the market now surpasses 1,000, a 40-times increase in the last decade. Europe is the leader in this space, however even in the European Union ESG funds make up just 7% of total assets.
These structural drivers are allowing investors to take a moral stand, leading to a surge in the number of ESG funds"
This shift will partly be driven by regulation, the analysts have said. Since 2017, the EU Non-Financial Reporting Directive has already required around 6,000 EU companies to publish ESG data in their annual results.
At the same time, there are a growing number of regulatory requirements putting pressure on companies to take ESG into effect, such as the Task Force on Climate-related Financial Disclosures (TCFD), as well as a rising number of voluntary disclosures initiatives as the UN Global Compact and Sustainable Development Goals (SDGs).
According to the report, the growing regulatory backdrop for reporting requirements "has also led to a surge in data providers enabling both active and passive investors to adopt ESG sustainability factors".
Additionally, there are three key secular factors that are fuelling the rise of ESG. One of these is the rise of ecopolitical parties gaining power, with an increasing number of seats in the European Parliament won by green parties over the past decade.
At the same time, the investor base is changing, with climate a key consideration for many millennials, while the advantage of ESG strategies has been supported by ten years of "persistent outperformance from higher-rated ESG stocks" versus peers, the report said.
"These structural drivers are allowing investors to take a moral stand, leading to a surge in the number of ESG funds," said Paulina Strzelinska, a quant strategist at the firm and one of the authors of the report.
In fact, the analysis has found that incorporating ESG factors could improve profitability and returns of companies across all sectors of the economy, improving the quality and longevity of the businesses.
"In Europe, MSCI AAA-rated ESG stocks have a third of cost of credit protection than CCC-rated ESG stocks by MSCI," the report said. "Moreover, the top quintile of ESG-rated stocks on average has traded at a 20% premium to bottom quintile ESG-rated stocks over the past ten years."
In terms of sector exposure, the analysis found that European funds focused on ESG tend to be particularly overweight utilities, industrials and discretionary stocks and underweight healthcare, energy and financials versus the MSCI Europe index.
This article was first published by InvestmentWeek, a sister title to International Investment.