Sustainable Investing 4 reasons for the rise of sustainable and impact investing
Sustainable investing is smart investing. The rise of sustainable and impact investing reflects the growing conviction that changing the world for the better is a responsibility as well as an investment opportunity.
To understand why sustainable investments have nearly doubled since 20141), it helps to think about the future. The prospect of a safer, healthier and more prosperous world by 2030 – the ambition of the 17 interconnected United Nations Sustainable Development Goals (SDGs) – may be a strong motivator, yet it cannot alone explain the dynamic growth in this investment segment.
With sustainable investments reaching $30.7 billion in 20181) it is clear that more investors are allocating capital where they believe it can make a difference.
In effect, the relatively sudden ascent of sustainable investing and its thriving subset, impact investing, may be attributed to the convergence of four factors.
A world in need
The launch of the UN SDGs in 2016 helped provide a framework – and language – for addressing the world’s most pressing environmental and social challenges. At present, the effort to limit global warming to 1.5°C above pre-industrial levels (below the 2°C threshold of the 2015 Paris Agreement) has yet to succeed. These few tenths of a degree matter, according to global warming climate risk scenarios. When projections around increased energy demand and population growth are taken into account, it is clear that keeping the UN SDGs on track will require immense international cooperation, engagement and coordination.
The UN, however, estimates a $2.5 trillion annual UN SDG financing gap in developing countries alone. To close this gap, there is an urgent need to mobilize funds for the transition to a low-carbon, climate-resilient world. It is also crucial to bolster the companies and start-ups that can deliver the right products, services and technologies to accelerate change.
A passion for purpose
It is no accident that the growth of sustainable and impact investing coincides with the maturing of Generation Y and Z as investors. Millennials have shown great interest in environmental and social causes, as well as an affinity for gauging the effectiveness of their engagement.
Equally telling are the findings of a 2018 Credit Suisse survey of over 200 Next Generation leaders, revealing a pull towards investments that can create long-lasting impact for their family and the greater good. Yet, while 62% expressed interest in impact investing, only 24% currently hold impact investments.
This may partly stem from a lack of clarity – prevalent among other categories of investors – about where sustainable and impact investing fits on a spectrum with traditional investing and pure philanthropy. Misperceptions about the liquidity and risk of impact investments are also abundant. At the same time, a growing number of investors, both private and institutional, are determined to generate financial returns and positive impact, using the UN SDGs as their point of reference.
Competitive financial returns
Today, sustainable and impact investing covers a spectrum of strategies, starting with the exclusion of controversial sectors/companies from the investment universe. The more positive strategy of ESG integration selects companies that perform well against ESG criteria. The goal is to use insights on material ESG-related risks and opportunities in combination with financial research in order to make better-informed investment decisions.
A sustainable investment strategy helps safeguard investment portfolios against climate-related regulatory, reputational and legal risks. The companies that integrate ESG practices into their strategy and operations tend to be less vulnerable and more attractive to investors.
As for the returns, the relative youth of the sustainable investing sector explains the lack of standardized metrics and indices. However, an increasing body of research confirms a positive correlation between corporate sustainability performance and financial performance – across all asset classes and in both developed and emerging markets. The most extensive meta-study to date, from the University of Hamburg, examined more than 2,200 separate studies. Over 90% of them found no negative correlation between inclusion of ESG factors and corporate financial performance – and the majority detected a beneficial impact. The development of artificial intelligence-enabled metrics also bodes well for a sector that delivers healthy returns, if not outperforms.
In short, sustainable investing is simply smart investing. And as the public, governmental and market view of corporate behavior continues to evolve, with ESG criteria an increasing part of performance assessment, the very nature of finance will change. The rise of sustainable and impact investing reflects the growing conviction that changing the world for the better is a responsibility as well as an investment opportunity.
More options for clear impact
The most staggering growth is taking place in UN SDG-thematic and impact investing, which focuses on measurable high-impact solutions. The UN SDG-thematic and impact investing market remains small compared to the more-established sustainable investing strategies. There is enormous potential, however, to mobilize capital towards projects that generate financial returns and benefit the environment and/or society.
Thematic and impact investing targets companies whose mission revolves around their contribution to specific UN SDGs. Pure impact investing goes further still, focusing on investments that can show a direct contribution to positive social or environmental impact – for example by funding the growth of impactful companies in private markets or via shareholder engagement in listed equities.
This kind of investing allows the investor, whether an individual or institution, to actively engage with innovators. These forward-thinking companies or start-ups could be driving decarbonized economic growth and the circular economy forward; The level of engagement ranges from input on the company mission to active ownership.
Impact investing is distinguished by three core elements:
- An investor’s intentionality and strategy of change to generate social and environmental impact
- An investor’s clear and direct contribution (also referred to as “additionality”) to the impact of the enterprise via financing growth or active ownership
- The measurability of impact outcomes (ensures the impact achieved is measurable and reported on)
It is no surprise that private equity and private debt sit at the core of the impact investment market, which has grown by 737% from 2014 to 2018 to more than $502bn in assets (2019 Global Impact Investing Network report).
1) Global Sustainable Investment Review 2018