Here are five key challenges that we believe investors are – or will – face in 2025:

1. Increased divergence on sustainable investing commitments 

We expect the global shift to the political right to persist. This, in turn, will continue the divergence of sustainable investing issues worldwide. Some players will roll back sustainability commitments, while others will double down. Global entities, in particular, will need to manage the regulatory and litigation risks this will bring.

Financial institutions are having to navigate this divergence. Many US asset managers are pulling out of climate initiatives, while UK and European asset managers are re-doubling their efforts. For example, Dutch pension fund PME said it may move away from a manager, given the investment company’s exit from the Net Zero Asset Managers Initiative (NZAM) and Climate Action 100+ (CA100+). This view has been repeated by other clients and consultants during our research.

2. Carbon target reset year

The 2030 deadline set by most companies to reduce their emissions is fast approaching. For many corporates, 2025 is a halfway point in their emissions target setting and a time to review progress. We expect many to realize that the targets set were overly ambitious. Indeed, many were aspirational targets, and much of the expected policy support never materialized.

We expect to see a lot of resetting of ambitions, leading to increased engagements, shareholder resolutions, and potentially even litigation over misleading claims. We predicted this in 2022, having said that the gap in credibility and policy support would lead to many targets being reviewed.

A rolling back of targets could negatively affect holding these companies in sustainability funds, especially for funds where there is a transition focus. An example is the technology sector, where the growth of power-hungry artificial intelligence (AI) means that emissions targets are increasingly difficult to achieve. Given AI-linked company dominance in the stock market, this will need to be addressed by investors.

Meanwhile, companies in the electrification market – such as ABB, Schneider Electric, Quanta Services, and Emerson Electric – have all benefited from AI growth, the energy transition, and longer-term improvements in grid regulations. We believe this highlights the electrification market as an area of opportunity for investors.

The rollback of the US Securities and Exchange Commission's climate disclosure rule will mean there are fewer disclosure pressures on US-based companies. Elsewhere, more detailed disclosure in the form of climate-transition plans is required, for instance, in the current and upcoming regulations in the EU and UK. These regulations will provide further clarity on if and how companies will achieve targets. This increased focus and scrutiny is likely to provide further impetus for companies to review and reset existing targets. This will help investors who are looking for energy-transition holdings for their sustainability funds.

We expect technology and financial institutions to face the biggest gap between stated emissions targets and their realistic ability to achieve them. They will be the most likely to reset targets. The flip side is that some intensity targets set by financial institutions have been surprisingly easy to achieve despite no demonstrable or real-world decarbonization. Is this the year the elephant in the room of real-world decarbonization is tackled? Early signals are that a more pragmatic approach will come.

3. Need to increase defense spending

Many NATO countries, particularly in Europe, have recognized the need to increase defense spending. This is because of conflicts in Ukraine and the Middle East, as well as previous underinvestment in defense in certain countries. Spending on defense will rise, but given stretched budgets, governments will be looking to investors for support.

Last year, some governments and investors raised concerns that the limitations on holding certain defense stocks in some sustainability funds were impairing investment in the industry. In their view, it could present a risk to national security. This could put pressure on regulators to provide guidance and alignment on how the defense sector should be considered in investments. A regulatory tilt towards allowing certain defense stocks to be held in sustainability-focused funds could change the investor view on this theme. However, with regulation moving slowly, this could take time to emerge, and managers also need to be cognizant of clients’ expectations on holdings in these types of funds.

4. Diversity, equity, and inclusion

We are seeing companies, fund managers, and other organizations, mainly in the US, rolling back on corporate diversity, equity, and inclusion (DEI) programs and targets. Meta, Amazon, Google and McDonalds, for example, have all altered their DEI policies, seemingly in response to the new US administration’s anti-DEI actions. We expect to see more companies react this way in the US and Canada.

From a bottom-up perspective, we expect more US-based companies to face more challenges in their environmental, social, and governance (ESG) practices. This includes what some are calling 'anti-ESG votes'. This reflects the changing regulatory landscape on the issue of DEI in the US.

According to Institutional Shareholder Services, these types of votes made up over 25% of those issued in the last year. As with climate target rollbacks, we expect similar reactions from investors and greater division linked to politics. This trend and the pressure on companies will likely increase. Investors will need to understand the challenges companies are facing.

5. Physical risks come home to roost

As the global economic costs of increasingly extreme weather rise, investors will no longer be able to ignore physical risks – whether they attribute the cause to climate change or not. We are already seeing, for example, that some areas will find it increasingly difficult to obtain insurance because of rising wildfire and flood risks.

We are currently looking at solutions to further enable us, and therefore our clients, to understand how physical risk could affect assets. There is also a growing understanding that adaptation investments will be needed to mitigate these physical impacts.

We expect to see an increase in the use of geospatial tools that include climate scenario analysis to help investors understand these risks. We also expect clearer disclosure from corporates to show how they are adapting to these risks.

Important information

Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.

Companies mentioned for illustrative purposes only and should not be taken as a recommendation to buy or sell any security.

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