Sustainable investing, which takes full account of environmental, social and governance factors, has come of age. More than $1 in every $4 of assets under professional management has a sustainability mandate, making a total of about $22.9 trillion.
A clear majority of institutional asset owners feel a responsibility to address sustainability through their investments, and there is a consensus that such opportunities exist across all asset classes, including public equity, fixed income, hedge funds and private equity.
Much remains to be done, however. There is a gap between intentions and implementation of ESG integration. There remains a belief that ESG-related investing means sacrificing performance. There is the need to address the sometimes-vexed question of what constitutes a sustainable investment.
Before considering that, it makes sense to first look at what lies behind the remarkable growth of sustainable investing in recent years, with a compound annual growth rate of 11.9%.
There are three key factors.
The first comprises the regulatory and legislative pressures on industries thought to be irresponsible, environmentally unfriendly or simply undesirable. These have appeared in an uneven way around the world, but the overall effect has been to make ESG investing a considerably more attractive proposition for asset owners.
The second has been a move toward the investment community of clients asking questions about investment decisions and expecting answers. Funds need to be able to explain why they are investing in any given company. Clients have put the moral compass of the industry under scrutiny and are asking about the sustainability of profit and cash flow in the long term. The Nordics and Dutch were early to this trend, with the Germans coming a little later. Now the trend is rapidly becoming global. It is a lot easier to give satisfactory answers if the companies in which you are invested meet sustainability criteria.
The third factor is the great increase in both the global availability of data and the speed with which social-conscience issues can take hold in society. Younger buyers tend to be agnostic about who they invest with but far from agnostic about wanting their investments aligned with their values. Traditionally, client acquisition was the hard part, retention was not. With younger investors, acquisition is relatively easy and retention is not.
So much for the drivers of growth. What of the challenges facing sustainable investing?
There is a gap between asset owners' declared intention to incorporate ESG criteria into investment strategies and their actions in this area. More than three-quarters of the institutional asset owners agree they have a responsibility to address sustainability through their investments, but the proportion of assets governed by an ESG mandate is about one-quarter.
Why is this? Well, it is not unique to sustainable investing. Whenever a new asset class emerges, it is common to hear asset managers declare that, in the long term, they want to be 15% invested in alternatives or in hedge funds or whatever the asset class in question. Return a few years later and you might find their allocation remains rather closer to, perhaps, 4%.
In part, this implementation gap arises from a lack of available products to choose from. In part, it results from the fact that this remains a relatively conservative industry.
And in part, it can be explained by the mistaken but lingering view that sustainable investing necessarily involves sacrificing performance for principles. However, this is not the case. ESG investing seeks sustainable revenue streams. This approach will find companies that score well on the morality scale and that will also perform well as investments.
As for the question of what "counts" as a sustainable investment opportunity, the current confusion in this area has led to demands for global standards that will leave no one in any doubt as to what qualifies and what does not. At this point, this may be overambitious, given differences round the world, and that a series of regional standards is more likely to emerge.
There have been fears of "greenwashing," in which mainstream investments are given a spurious ESG coating. The growing sophistication of investors would allow them to see through attempts to game sustainable investing, but third-party providers can help reassure asset owners as to the authenticity of investments, using both their experience and the growing bank of academic evidence in this area.
Today, just more than 25% of professionally managed assets are sustainably invested. In five to 10 years, that figure may well be 80%.
What is happening here is nothing less than a slow revolution — slow, but unstoppable.