This past year has provided valuable insights for those interested in understanding the evolving forces shaping the market and their impact on investor behaviour. The complex interplay between momentum, monopolies, political developments and sustainability standards has exposed significant tensions for sustainable investors.
According to MSCI, the momentum factor has historically been one of the strongest generators of excess returns for equity investors. Sustainable funds benefitted from this for many years through the collinearity with the ‘quality growth’ factor, which performed well until global interest rates began to normalise in 2021.
Momentum, however, is a fickle friend, prone to unpredictable shifts. While it can drive significant returns, its influence can change direction swiftly as investor preferences evolve. Recently, momentum has been concentrated in AI-related technology stocks, which saw a resurgence after the 2022 bear market for the ‘magnificent seven’.
The powerful price momentum in technology stocks has been amplified by their immense size, with some companies now valued in the trillions of dollars. These mega-cap companies have dominated index returns, further narrowing market leadership. Not owning stocks like Nvidia, Amazon, TSMC, Microsoft, Alphabet, Broadcom or Meta made it challenging for global equity managers to beat the index over the last two-years.
The small-cap risk premium, also known as the ‘size effect,’ is a favoured factor among active managers and has historically rivalled momentum in delivering returns. However, in recent years, small-cap stocks have experienced prolonged underperformance despite historically low valuations compared to large-cap companies, making life challenging for active managers.
For investors focused on sustainability and impact, the momentum factor presents a challenge. Can momentum-driven performance, dominated by a few mega-cap stocks, align with genuine sustainability outcomes?
The new Sustainability Disclosure Requirements (SDR) from the FCA aim to set clear and high standards for funds with sustainability-related terms in their names, and a higher bar still for those funds wishing to apply one of the four new sustainability labels. After the wave of greenwashing following the introduction of the EU’s Sustainable Financial Disclosure Requirements, this is welcome, even if it will be challenging for fund managers to demonstrate their alignment with well-defined sustainability outcomes to attain a label while retaining flexibility to rove across all parts of the market.
Emerging regulatory standards increasingly expect sustainable funds to demonstrate an alignment with robust, measurable sustainability characteristics; simply excluding certain activities is no longer sufficient. Like any other investment strategy—whether value, income, or growth—sustainable funds must clearly define their eligible activities. This is particularly important in a narrow, momentum-led market, where managers may feel pressured to chase mega-cap stocks, even if these companies’ sustainable activities—based on revenues or capital expenditure—are low or their corporate behaviours are questionable.
Antitrust and monopoly issues are becoming a growing focus for politicians and regulators, raising important questions for sustainable and impact investors. The EU and the Federal Trade Commission (FTC) in the US have been actively pursuing court cases designed to rein in excessive corporate power and industry consolidation.
On 6 August, Judge Mehta ruled Google violated the Shermann Antitrust Act by excluding rivals from the internet search market. In his summing up, Judge Mehta concluded “Google is a monopolist”. In response, the US Department of Justice is considering a breakup of Google. Additionally, in early July, Google issued a report highlighting that its total greenhouse gas emissions (direct and indirect) had risen by 50% in the five years since 2019; in 2023, energy-related emissions alone rose by 23%. Similarly, Microsoft revealed dramatic growth in emissions, driven by the impressive expansion of their wide-ranging business. Social media companies have also been criticised for doing too little to tackle the spread of misinformation and harmful materials on their platforms and for their role in the recent riots in the UK.
Antitrust and monopoly issues are a growing focus for politicians and regulators around the world and raise interesting questions for sustainable and impact investors. The EU and the Federal Trade Commission (FTC) in the US have been active in pursuit of court cases designed to rein in excessive corporate power and industry consolidation.
Antitrust issues are also making headlines in the run-up to the US presidential election. JD Vance, Trump’s running mate, has praised activist FTC Chair Lena Kahn, one of the few Democrats he supports. Meanwhile, some billionaire Democratic donors have urged Kamala Harris to remove Kahn if she wins, reflecting the contentious role antitrust policy will play in shaping corporate America’s future.
The Chevron deference ruling by the Supreme Court is also worthy of note, as for many it is something more profound than a ruling clarifying the interpretation of administrative law. There is an expectation that this ruling could sweep away the bureaucratic burden of regulation on US companies, potentially boosting corporate profits. While investors might welcome the prospect of higher profits to support returns, it raises concerns about how checks and balances on concentrated corporate power will function, especially if the current mandate of the FTC is diluted.
Sustainable investors may find welcome relief in the recent break in the momentum trade, which began to emerge in early July and intensified in August. This shift, driven by an unexpected rise in Japanese policy rates that disrupted crowded momentum trades, offers a chance to refocus on their sustainability objectives without the commercial pressure of blindly following the market’s mega-cap leaders.
