Sustainable Investing: the way forward
Macro trends like climate change, increased public awareness, and governmental as well as legislative and regulatory change have spurned a shift in investor preferences and visibly driven demand for generating returns sustainably.
Today investors can invest sustainably through a number of different approaches.
- Exclusion: Whereby investors can avoid harm by actively choosing to exclude sectors or companies that are involved in controversial business areas or in severe business practice controversies. There are two types of exclusion strategies: Norms-based exclusion and Values-based exclusion. The former is an approach based on international treaties, such as controversial weapons. The latter is based on an investor's preference to exclude investments in business activities that have a negative impact on society or the environment, such as thermal coal or tobacco.
- ESG integration: Whereby investors may benefit from an investment strategy that focuses on integrating material ESG risks and opportunities into the investment decision making process, alongside traditional financial research.
- SDG thematic and impact-aligned investing: Whereby an investor can allocate capital to gain exposure to high impact, and often high growth, companies that place the UN SDGs at the center of their purpose and operations
- Impact investing: Where an investor is allocating capital with the explicit intention of having a positive, measurable social or environmental impact, in addition to financial returns
The growing demand for sustainable investing solutions is propelling innovation at financial institutions that are constantly seeking to expand their sustainable investing offerings to accommodate client preferences.
Why Sustainable and Impact Investing?
A study conducted by the Global Sustainable Investment Alliance (GSIA), in 2018, pointed out that sustainable investing is rapidly becoming the "new normal". Proof of that is in the market's growth rate.
- The sustainable investing market has grown exponentially from 2014 to 2018, up by 74%, accounting for USD 30.6 trillion assets under management (AuM).
The impact investing market, a subset of sustainable investing, has also grown.
- According to a recent report by the Global Impact Investing Network, the impact investing by the grown by substantially to USD 715 billion of AuM in late 2019, from USD 77.4 billion of AuM in late 2015.
The rise of sustainable investing 1992-2019
Aligning values with investment activity
The growth in sustainable and impact investing over the last few years has shown how our new environmental and social paradigm has marked a shift in investor preferences and demand. The next generation of ultra-high net worth and high net worth individuals are keen for investment opportunities to represent personal and social values, and institutional investors, who safeguard the pensions of future generations, are keen for investment opportunities that take environmental, social and governance (ESG) risks and opportunities into account.
Another aspect that has truly driven the rise in sustainable investing is the regulatory, legislative and governmental engagement on the topic. Recent legal opinions and regulatory guidelines consider it as part of an institution's fiduciary duty to consider ESG issues when investing. In 2018, over 170 new ESG regulations were passed, a significant increase when compared to fewer than 20 in 2008. This has driven, largely institutional investors, to rethink capital allocation strategies.
ESG factors affect financial performance
But it isn't just macro-factors that are driving a shift in investors' preferences. Morningstar's 2019 sustainable investing report found that companies in the bottom quintile of ESG ratings experienced large drawdowns three times more frequently versus the top quintile. Furthermore, the report explained that ESG indices tend to include companies that are less volatile and possess stronger competitive advantages and healthier balance sheets than the non-ESG equivalents. The correlation between systematically considering ESG issues and value creation is solidifying. As more evidence points to this link, financial markets will change permanently. This mass transition will reverberate throughout financial markets and touch everything from capital markets solutions and advisory to capital allocation, portfolio construction, corporate disclosure as well as asset and wealth management advisory.