Public interest in sustainable investing – also known as ESG (environmental, social and governance) investing – has been steadily gaining momentum in recent years.
This has been driven in part by greater awareness and activism on global sustainability issues such as climate change and worsening inequality, spurring more individuals to seek positive change through sustainable investing and other means.
For those still new to sustainable investing, the explosion in recent developments may prove daunting. It is therefore useful to revisit some basic concepts.
What is sustainable investing?
While precise definitions vary, sustainable investing – also known as socially responsible investing – can be described broadly as an investment approach guided by the aim of achieving a better and more sustainable future for society as a whole – and not just the individual investor. Sustainable investing thus requires consideration of environmental, social and governance (ESG) factors in the investment process, and is often also referred to as ESG investing.
Broadly, the practice of sustainable investing today can be categorized into three main strategies:
In its early days, sustainable investing was widely viewed as demanding the sacrifice of investment returns by excluding lucrative industries (defense, fossil fuels and tobacco); or requiring investments in high-risk ventures such as unproven clean-energy technologies or social enterprises where the profit motive is explicitly subordinated to ESG goals.
Unsurprisingly, many investors keen to effect positive social change initially preferred to base their investment decisions primarily on financial criteria, and set aside a separate budget for engaging in philanthropy, thus effectively treating their wealth generation and ESG activities as distinct.
Over time, however, this view has evolved significantly. Many investors now take a more sophisticated approach to sustainable investing, systematically incorporating ESG factors into their investment process, and engaging more directly in impact investing to improve the ESG outcomes they seek.
There is also a small but growing body of evidence that shows that ESG factors can be integrated successfully into the investment process without sacrificing returns.
A 2018 review of academic research by NYU Stern and investment firm QMA found no strong evidence of a significant difference in the returns earned by firms with high or low ESG ratings. Overall, companies with better ESG profiles are able to raise debt and equity financing more cheaply, and enjoy higher valuations, the review showed.
Recent surveys also suggest that sophisticated investors engaged in sustainable investing no longer believe that returns must be sacrificed in the process.
The Global Impact Investing Network’s latest survey published last month shows that two-thirds (66%) of the 266 impact investors surveyed principally target risk-adjusted market-rate returns, while the rest aim for returns close to but below market rate (19%), or capital preservation (15%).
Sustainable investing assets under management across equity, fixed income, real estate, and private equity grew to US$30.7 trillion in 2018, more than double the US$13.3 trillion in 2012, latest data from the widely tracked annual survey by the Global Sustainable Investment Alliance show.
Exhibit 1: Estimated total global sustainable investment assets (2012-2018, in US$ trillion)
Source: Global Sustainable Investment Alliance, Global Sustainable Investment Review 2018
Improved ESG frameworks and greater sense of urgency to tackle ESG issues driving sustainable investing trend
We see three key, mutually reinforcing developments that are driving interest in sustainable investing.
Many global financial data providers such as Bloomberg, Refinitiv, MSCI, FTSE and S&P Dow Jones Indices now offer progressively more refined ESG securities ratings and benchmarks. This has helped to improve and expand investors’ ability to integrate ESG criteria into their investment process.
A useful indication of sustainable investing’s growing penetration into the mainstream is the steady rise in the number of signatories committing to the UN-led Principles for Responsible Investment. Nearly 2,400 asset owners and managers representing US$86.3 trillion in assets under management (AUM) have signed up so far, compared to just 63 signatories with US$6.5 trillion of AUM in 2006 when it was launched.
Exhibit 2: Growth in number and total assets of global signatories committing to the UN Principles for Responsible Investment
Source: UN Principles for Responsible Investment
As ESG methodologies improve, industry standards emerge and social awareness on global issues grows further, we believe that sustainable investing principles will become an increasingly essential part of the investment process – in the same way that sophisticated investors today expect a minimum standard of financial due diligence done before risking their capital.
We see signs of a virtuous circle developing, with growing interest in sustainable investing supporting the development of improved ESG metrics and industry standards – leading to more consistent and timely ESG data, closer integration of ESG factors into investment decisions, and greater availability and customization of ESG products, further reinforcing demand for better ESG offerings to help investors to invest sustainably.
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