Sustainability searches on Google were at record highs, worldwide in 2021. This does not come as a surprise, as assets in sustainable funds continued to trend upwards and hit new highs in 2021. Globally, more and more investors are putting their money into sustainable investments.
Sustainable investing is not a singular approach but instead, represents a range of methods that investors can use to generate competitive investment returns while helping create positive outcomes for people and the planet alike. There are numerous terms that are used interchangeably, depending on who you talk to - sustainability investing, ESG (environmental, social, and governance) investing, impact investing, and responsible investing.
With socially responsible investing (SRI), the focus is often on exclusionary screening to ensure that a portfolio reflects the values of an investor. It is also known as ethical investing and seeks to avoid industries that negatively affect the environment and its people. SRI is customizable as investors can list products or industries that clash with their values and exclude them from their portfolio.
ESG investing involves strategies that inevitably take a company’s environmental, social and governance factors into consideration. This is a broad umbrella that includes carbon emissions, energy efficiency, waste management, human rights, labor standards, audit committee structure, and board composition.
From a value-based perspective, the reasoning that drives sustainable investing is that directing capital toward companies that are dealing effectively with sustainability issues will enhance the transition to a more sustainable, global economy. By doing so, investors concerned with sustainability may also achieve superior performance on their investments because many companies that are effectively addressing the ESG issues impacting their businesses tend to be promising long-term holdings.
Impact investing refers to attempts to measure the positive environmental or social outcomes of a given investment. Impact investors are focused on targeting specific goals and the impact desired.
Sustainable investing is primarily about investing and not social or environmental activism. However, it does have an impact on the world. You may be attracted to sustainable investing because of your own social or environmental concerns, but the focus of a sustainable fund is to generate competitive investment returns to help you reach your financial goals. That said, by making a sustainable investment, you are making more impact with your money, than if you invested in a conventional way. Across the world, investing with a sustainability lens is becoming foundational to how more people want to invest. Much of industry talk says that investors must make a choice between improving investments or improving the world. But investing success and personalized impact are not binary. It's not a zero-sum game. You do not have to choose one or the other to be successful.
Why Should Investors Worry about ESG Risks?
ESG should matter to investors because it identifies potential risks that could affect a stock price. Just like investors would want to know if a company could run into trouble from having too much debt, or selling products in a declining industry, it is important for investors to consider ESG risks that could hurt a stock. For example, chemical companies face risks from environmental damage that can cost billions of dollars to clean up, such as asbestos lawsuits that left many companies bankrupt. Similarly, beverage companies must continually monitor their water use as they may have to pay higher costs or even stop producing beverages if they use too much water. Any company whose employees are unionized is at risk that their employees will go on strike due to poor working conditions. All of these are ESG risks that could hurt investors.
Evaluating Long-Term Risks Including ESG Risks is Fundamental to Investing
Beyond values, ESG factors are key risks to corporate sustainability, and these risks are as important as any other ones facing companies. Just as businesses cannot ignore material risks from new competitors or changing technology, companies cannot afford to ignore material risks that climate-change, or government regulation to curb it might present to their production capacity. They cannot ignore the risk that their employee health and safety practices might lead to a dearth of willing workers if labor markets tighten, or the risk that their management team may not be properly incentivized to focus on long-term results.
Different companies have different material ESG risks, and different industries have a range of exposure levels to diverse types of ESG risks. But the long-term profitability of any investment can be undermined by unmanaged ESG risks, which means that considering these risks cannot be a mere checklist. Since ESG risks are relevant for long-term investing, they should be included in security analyses. Failing to do so, can lead to an over-estimation of a security’s fair value
Trends in Sustainable Investing
The global sustainable fund asset rose to USD 2.8 trillion in 2021. Flows into sustainable funds in 2021 were in excess of USD 600 bn. While Europe still leads the pack with 80% of the overall sustainable assets and flows, United States and Asia Pacific are also witnessing increasing flows into sustainable funds. Investors' demand for strategies that align with their values and sustainability preferences continues to grow, prompting asset managers to launch additional sustainable products and repurpose existing conventional ones.
Supported by its strong regulatory agenda, and the EU's Sustainable Financial Disclosure Regulation in particular, Europe has seen consistent growth in sustainable fund assets over the past couple of years in a significant manner. Overall, sustainable funds accounted for more than 17% of European fund assets at the end of March 2022.
In India, we have witnessed increased interest in sustainable funds over the last couple of years, with sustainable fund assets now standing at USD 1.5 bn - up from USD 350 mn at the start of 2020. While the numbers are still quite small in comparison to a global context, many Indian asset managers are already incorporating ESG risk assessments into their overall investment processes.
This growing demand from investors has led many asset managers to increasingly incorporate ESG risk factors into their process, though many are going further and developing sustainable and impact strategies. Asset managers are also taking their responsibilities as stewards more seriously by pushing companies to manage their ESG risks and consider the impact of their operations on the environment and society.