Quarterly Market Currents: Political Noise Contradicts Reality for Impact Investors
After a whirlwind 2024, 2025 kicks off with big shifts and fresh opportunities for impact investors:
What’s next for impact investors after November’s election result?
The fundamental law of real estate still stands - location, location, location - but, climate-change may be redefining what location means.
Private credit is now one of the most popular asset classes: what does that mean for impact investors?
Equity markets may have found footing outside the narrow set of stocks that powered returns throughout 2024.
Read on below for more on the currents moving markets in the first quarter of 2025.
Election Fallout and The Long Game for Impact Investors
Oceans of ink have been spilled on November’s election, with our own pre-election analysis in Q3 detailing several chief potential ripple effects for impact investors. With the election now in the rearview mirror, our focus is squarely on this administration’s policies and potential actions that may alter the impact investing landscape:
The Political “anti-ESG” Movement: Anti-ESG bills and court rulings have gained little traction to date. However, the movement received a notable win in early January with a Texas federal judge ruling that American Airlines “violated federal law by filling its 401(k) plan with funds from investment companies that pursue environmental, social, and corporate governance goals.” It’s important to note that this ruling remains subject to appeals and is explicitly focused only on retirement plans. But, if successful, would mark the first major ruling in favor of the Anti-ESG movement. We are closely watching if, and how, ESG-related investments could be affected, more broadly.
Deregulation of Fossil Fuels: Globally, investment in renewable energy sources has begun to outpace traditional fossil fuels - in fact, investments in renewables outpaced traditional fossil fuels by $2 Trillion to $1 Trillion in 2024. Meanwhile, President Trump has vowed to shift the focus back to fossil fuels in the US via a myriad of deregulation efforts that make oil drilling easier. In reality, the exponentially increasing rate of global energy demand will likely continue to push the market for diversified energy sources, and, thus, renewable investments are not likely to evaporate long term. However, the fossil fuel push by Trump’s administration may mean a shorter-term pop in fossil fuel-related stocks and relative underperformance of impact portfolios with less exposure to fossil fuels.
Discussed last quarter: SEC Climate Disclosure Regulations, The Inflation Reduction Act
In short, while political shifts like the anti-ESG movement and fossil fuel deregulation pose near-term challenges, in our view, the unstoppable momentum toward sustainability and renewable energy remains.
Is Climate Change Breaking Insurance?
“We’re marching toward a future where insurance is not going to be available or affordable,”
- Dave Jones, director of the Climate Risk Initiative at the University of California at Berkeley’s School of Law
At Align, we think a lot about mispriced risk. At times, mispriced risk can come from government intervention in markets, such as California insurance. The fundamental idea of insurance is to pool risk among a large group, and, thus, diversify it. Diversification breaks down when things like human-driven climate change increase the level of risk for the entire group all at once. The only way to compensate for this is to increase prices or kick folks out of the group. Yet stringent regulations in California force insurers to continue to offer insurance to fire-prone areas or abandon the market entirely, while artificially restricting price increases.
Ultimately, when there is a disaster, there are three broad groups that will pay for it: insurers, individuals, or governments (i.e. taxpayers). So, while the California wildfires are having an immediate impact on California, in the words of CFRA analyst Cathy Seifert, “Homeowners outside California should not get a false sense of security about their situation vis-à-vis homeowners insurance.” Here are the ways that the fires could impact you:
Possible increases in insurance prices outside of CA: Cross subsidization involves charging one group more to subsidize another. CA has some of the strictest limitations on price increases, thus, insurers must increase insurance rates more in other states, where the regulations are less stringent. However, the problem of pricing risk in property and casualty insurance has become so severe, that some industry analysts are questioning whether it is a profitable business line at all.
As houses potentially become more expensive to insure, and the ability to secure insurance in some areas disappears entirely, properties in at-risk areas could see their values decline. After all, the fundamental law of real estate still stands: location, location, location. Climate change is redefining what this law means, as views and access to amenities may give way to the physical safety of a location.
Why is Everyone Talking About Private Debt?
Interest rates remain in focus across asset classes as the Fed continues to move markets. On the private debt front, direct lending strategies returned 11.1% in 2023 net of fees, beating buyout funds and most other private market strategies, according to data from Pitchbook. While certain segments of the private markets, like VC, saw a significant pullback in capital flows thanks to higher rates (as discussed in our Q2 Market Commentary), direct lending was on track to have another record year of fundraising, according to Pitchbook Data as of H1 2024. Direct lending strategies, which often make variable interest rate loans, are attractive in a rising rate environment. As calls for deeper interest rate cuts rose in the first and second quarters, then fell in the third quarter of this year on stronger than anticipated growth, the outlook for this asset class became somewhat murky.
Yet, this has not dampened the enthusiasm of large allocators to the asset class. Inflows to the largest private lending strategies have ballooned this market to the point that just 20 funds represent 33% of dry powder in the asset class. This could put the market in a precarious position. If interest rates continue to decline, these large asset managers may be forced to compete for lower and lower spreads and a lower base rate. What does this mean for the impact market?
One of the benefits of investing “down” market, in smaller companies and funds, is that as the largest asset managers duke it out for market share, these small companies and assets with limited absorptive capacity are sometimes overlooked, simply due to the vast amount of capital these larger funds need to deploy to any given deal. Furthermore, while typical private lending strategies, such as BDCs targeting the upper market, compete in a relatively commoditized market with similar term sheets, these smaller funds can have more flexibility to negotiate favorable terms, such as floors on floating rates, minimum interest rate charges, and prepayment penalties. Thus, while the private lending market as a whole looks poised for fierce competition, the lower and lower middle markets may still hold overlooked opportunities for experienced investment managers.
Equity Markets: Bulls on Parade
As we step into Q1 2025, equity markets appear poised to potentially broaden their rally, with broad earnings growth projected to surpass 14.8% this year, fueled by resilient consumer demand, AI-powered productivity, and stabilizing interest rates. While technology stock performance remained strong in Q4 2024, other sectors like industrials, healthcare, and consumer discretionary began stepping into the spotlight, signaling a shift toward broadening market performance.
Impact-related stocks could play a crucial role in this market strengthening. Clean energy and sustainable infrastructure companies are attracting capital as global commitments to reduce carbon emissions remain strong, despite political headwinds (see Election Fallout and The Long Game for Impact Investors section above). Energy may be poised to perform well, amidst political tailwinds in the US for traditional energy sources alongside steady projected increases in renewable energy capacity that may buoy recent stock volatility. 2023 and 2024 proved trying for impact investors with narrow investment focuses; indications are that 2025 and beyond may be more friendly across the equity market.
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The information presented in this newsletter is the opinion of Align Impact, LLC and does not reflect the view of any other person or entity. The information provided is believed to be from reliable sources but no liability is accepted for any inaccuracies. This is for information purposes and should not be construed as an investment recommendation. Past performance is no guarantee of future performance. Align Impact, LLC is an investment adviser registered with the U.S. Securities and Exchange Commission.
