Sustainable investing is slowly emerging as the sweet spot between asset managers seeking new sources of alpha and asset owners searching for steady long term gains as they de-risk and diversify their portfolios. All while boosting brand image and helping to achieve a better, more sustainable future for all.
Or at least that is what it says on the tin.
If we peel back the label, how “green” are these investments in reality? And what is their actual impact? Some investors are understandably sceptical.
In this article, we discuss the huge global adoption of this investment class, the challenges holding some investors back and the steps being taken to encourage critical capital market flows as we transition to a low-carbon economy.
The numbers tell their own story
From 2017-2018 sustainable investing experienced a ‘sea change’ – figuratively speaking, that is. New flows into Environmental, Social and Governance (ESG) funds reached USD 76 billion1 in 2018 and the green bond market grew to USD 168 billion, almost doubling in size from 20162. The BNP Paribas ESG Global Survey 20193 mirrors this bullish investor sentiment, forecasting tidal waves of capital injections. Of the 347 institutional investors who integrate ESG and responded to the survey, 90% plan to have at least one quarter of their investments in ESG funds by 2020. This is even a colossal jump from 50% of respondents in our 2017 survey4.
Doing good to look good
So what is driving this demand? According to our survey respondents, the promise of improved long-term returns is the main pull5. However, the second largest driver is something of a surprise: almost half of respondents voted for brand and reputation6, recognising the brand value benefits of industry engagement and a robust ESG strategy. This ranked ahead of what at first might seem the more immediate pressures of lower investment risk and regulatory requirements.
Indeed, in the absence of a global set of mandatory regulations, institutional investors increasingly understand the reputational necessity of adhering to best practice recommendations from organisations such as the TCFD7 and the PRI8. The latter has seen its membership numbers swell over recent months to 2,300 signatories, representing over USD 80 trillion in global AUM today9.
So is it all rosy in the land of milk and honey?
There is no denying investor optimism around sustainable investing. Nonetheless, our survey did uncover an element of investor frustration, which if overcome could provide a further boost for this investment class. And we will need a further boost. To meet the EU’s climate goals alone, it is estimated that an additional private capital injection of EUR 175- €290 billion a year will be required over the next ten years10.
So what is keeping investors at bay?
In our 2019 survey, two-thirds of respondents cite data as a key challenge. As the saying goes, no stream runs higher than its source, and in the same way, many of the limitations of this data stem from its source.
Sustainability data originates from the companies themselves via annual corporate disclosures. This task is often completed on a voluntary, “best-efforts” basis in line with best practice guidelines11.
In fact, from corporate data disclosures, to fund managers labelling their funds as “green” investments through to index vendors constructing ESG benchmarks; no over-arching global rules exist today to define, measure, or govern sustainable investments and much is left open to interpretation.
As a result, classifications, processes, methodologies and metrics can vary widely from one institution to the next. In fact, a 2018 study by Schroders12 found correlation as low as 0.2 between ESG metrics from different data vendors across the same investment universe. This concern is also backed up by our survey, where more than one quarter of respondents cite conflicting ESG ratings as a challenge.
Greenwashing muddies the waters
This lack of transparency and consistency also knocks investor confidence. One-fifth of our survey respondents cite concerns over greenwashing. This concern has, in turn, been highlighted by the Global Sustainable Investment Alliance in their recently-published 2018 Investment Review13.
Rather than rest on their laurels and rely on a “green” label, investors now actively seek out ways to assess the tangible impact of their sustainable investments. Indeed, 80% of survey respondents are using or plan to use the UN SDGs14 as a compass or benchmark against which to measure the impact of their investments. Although a giant leap for sustainability, it may compound the data challenge, in that the SDGs were designed for governments and policy makers and not for investment professionals. Thus metrics are not perfectly aligned and further work will be needed.
Lighthouse on the horizon
Fortunately, help is on the way. In recent years, industry groups such as the TCFD and UNPRI have continually lobbied for better governance and stricter reporting standards for sustainable investing
Furthermore, in June this year, the European Commission’s Technical Expert Group on sustainable finance published its draft taxonomy framework15. Although pending parliamentary approval, this framework is designed to promote “green” investments by tackling investor challenges head-on through new rules of engagement, namely:
- Clear, consistent definitions of “sustainable” investments that must also be intrinsically linked to climate goals such as the UN SDGs.
- Transparent, comparable benchmarking, obliging vendors to disclose key factors and methodologies.
- Guidance notes for corporate disclosures to promote clarity and consistency.
Whilst this draft taxonomy does not in itself offer a lifeboat for investors lost at sea, we view it as a vital and valuable foundation and enabler; a lighthouse in the distance guiding the market towards more holistic, transparent and consistent regulatory standards and encouraging future investment into this critically-important investment class.
3 The ESG Global Survey 2019: Asset Owners and Managers Determine their ESG Integration Strategies. BNP Paribas and Longitude Research
4 Great Expectations for ESG: What’s Next for Asset Owners and Managers? BNP Paribas and Longitude Research
5 52% of respondents cited improved long term returns as a Top 3 reason for ESG investment
6 47% of respondents cited brand and reputation as a Top 3 reason for ESG investment
7 The Task Force on Climate-related Financial Disclosures – an industry group set up to develop reporting standards for climate-related financial disclosures
8 The UN-supported Principles for Responsible Investment – a leading proponent of responsible investment
11 The Task Force on Climate-related Financial Disclosures and The Sustainable Accounting Standards Board have both published “best practice” recommendations to assist companies with corporate disclosure
13 Source: The Global Sustainable Investment Review 2018 reported a 10% drop in sustainable asset values in 2018 versus 2014 among asset managers in Europe. This was attributed to investors “anticipating a shift to stricter standards and definitions”
14 The UN Sustainable Development Goals (SDGs) were adopted by all United Nations Member States in 2015 as a universal call to action to end poverty, protect the planet and ensure that all people enjoy peace and prosperity by 2030