Sustainability Strategies Webinar

Sustainability as an investment strategy has explicitly embraced the dual goals of achieving risk-adjusted alpha as well as environmental and social impact – and the ways that investors can pursue it have expanded across themes, approaches and markets. From the “double dividend” and direct engagement to the “green premium” and measuring “externalities,” our panel of industry experts sheds light on the current strategies and metrics in sustainability. Join this lively discussion on what it takes to effectively manage ESG investments and assess emerging opportunities.

Featuring

Philip Carter

Investment Specialist, Venture Capital

HSBC Asset Management

Gordon Bennett

Managing Director, Global Head of Environmental Markets

ICE

Marco Lenfers, CFA

Client Portfolio Manager

Vontobel

Wednesday, November 29, 2023

2:00 p.m. ET

Register Now

The impact of sustainability — as an investment strategy and as an ideology embedded in the business ecosystem — is being felt by a wide range of stakeholders across the public and private sectors. Climate change and the energy transition toward a net-zero emissions economy are driving factors for today’s institutional investors focused on both risk management and alpha opportunities for their investment portfolios.

Sustainable investing continues to evolve, however, as investors define and redefine its terms, look for more consistent data and measurement of impact strategies, as well as consider how far they want to go with engagement policy. What’s evident is that investors worldwide are forging similar paths with the understanding that sustainable investment needs to be at the forefront of their decision-making and allocation considerations.

How investors view sustainability and what matters in terms of impact are ever changing. While climate change and the net-zero energy transition remain at the forefront of their thinking, many asset owners have expanded that view, said Marco Lenfers, client portfolio manager for listed impact equities at Vontobel. As knowledge deepens and world events occur, “biodiversity is coming up, although it’s clearly more challenging to find companies in which to invest and provide solutions that tackle biodiversity issues directly.”

The same is true for social issues. While in the early stages of consideration, they are also part of the sustainable investment journey. “Increasingly, people are looking at gender diversity, inclusion or equal opportunities as areas of focus. Social topics are becoming increasingly important,” he said.

Interestingly, impact investing has been evolving beyond the highly targeted private market investments where it originated. As environmental and social issues — including climate change, biodiversity and depletion of natural resources, as well as lack of equality and inclusiveness in society — have become more acute, approaches that originated in microfinance and private equity, for example, are now complemented by public equity and bonds, Lenfers said.

“What we need is scalability. And scalability is typically something that is provided by public markets. The intention is basically the same as in private markets — you look for something known as a ‘double dividend.’ In other words, investors want to generate market returns or higher and achieve some positive benefit for the environment or for society, depending on how you structure your strategy,” Lenfers said.

Today, many institutional investors recognize that sustainability challenges must also be addressed within public market strategies, even if they began their sustainable paths in private markets, he said. “Many investors aim to have bigger allocations to public markets versus private markets, so public markets will become increasingly important for them.”

Read: Environmental Markets: Why they’re needed and how they work

The idea of sustainability is not a one-size-fits-all solution, said Gordon Bennett, managing director and head of environmental markets at ICE. While climate change typically comes up as the biggest theme for investors, “one of the challenges with sustainability is that it means different things to different people, and they may have different priorities across the sustainability spectrum,” he said.

The term sustainability is often used interchangeably with ESG, or environmental, social and governance investing, Bennett said, adding that ESG is a relatively new phenomenon. “I would argue that the original framing of sustainability around people, planet and prosperity was a better definition.”

Each aspect can’t be viewed in isolation. For instance, while people and the planet are top of mind, we also need to look through the lens of prosperity. “Ultimately, you need profits to fund growth, so prosperity is a key component of sustainability,” Bennett said. “Consideration for the planet also has a strong link to people. So I think the climate component is the most important because if you don’t have a habitable planet, there are all sorts of economic and societal impacts.”

While the idea of sustainability has been around for decades, the deployment of capital in a sustainable way is relatively new, with approaches to evaluate and measure sustainable investments still being developed, Bennett said. “Part of the challenge for investors is, How do you measure risk and reward through a sustainable lens if there aren’t tools to price it? Can you invest sustainably or responsibly without adjusting for climate risk?”

He noted that 75% of the world’s emissions are not directly priced, and that greater consideration must be given to the utilization of carbon pricing. “Many stakeholders are struggling with how to deploy carbon pricing in their evaluation of risk and reward, and that’s because only a small percentage of investees are required to treat their emissions as a liability,” Bennett said.

ICE, which has been a leader in the environmental markets for nearly two decades, has long tackled this challenge. It now provides a range of products, including carbon allowances, carbon credits and renewable energy certificates in North America and Europe and globally through its nature-based and CORSIA carbon credits.

Source: Vontobel

“Environmental markets essentially provide investors with a way to internalize externalities,” Bennett said. In other words, these markets put a price on pollution, or negative externalities, through carbon allowances. They also put a price on activities beneficial to the planet, or positive externalities, such as protecting forests and generating carbon-free electricity by using carbon credits and energy attribute certificates, respectively.

“By valuing things that haven’t been valued before, you change the way you measure risk and reward. By starting to use environmental markets in business models, you can change the way that capital is allocated to technologies that are more sustainable for the planet,” Bennett said.

As investors continue to seek appropriate approaches for their capital and metrics on sustainability, technology tends to be front and center across most decisions.

“The role of technology in driving a net-zero transition across every industry on earth is the most prevalent theme in sustainable investing today,” said Michael D’Aurizio, investment director of climate technology at HSBC Asset Management. “For example, climate technologies are the fastest-growing investment area in venture capital.”

Institutional investors are becoming increasingly more sophisticated when it comes to evaluating a company’s approaches to sustainability and its environmental impacts. He noted that this is somewhat more advanced in public markets, where there are clearer reporting and disclosure requirements, and companies are better resourced to comply. Sustainable investing in private markets can require a more nuanced approach to assessing, managing and monitoring a company’s risks, opportunities and sustainable potential — especially when evaluating newer climate technologies.

Sustainable investing is a baseline requirement in a risk-management framework, D’Aurizio said. “Whether you’re assessing a public or a private issuer, you’re adding more variables onto your downside risk management in a way that is quantifiable.” Investors need to benchmark all risks that a company faces and understand how it plans to address and respond to these risks.

There is also a growing expectation that investment managers should allocate capital to companies that can achieve positive impact, whether that impact is focused on the environmental transition or on social impact, he said.

Global ESG-related assets are expected to grow 84% to $33.9 trillion by 2026, making up 21.5% of global assets under management, according to PwC’s “2022 Asset and Wealth Management Revolution” report, an industry survey of asset managers. Given that huge uptick in capital flows, where are the compelling opportunities?

Read: Adapt and thrive: What will the future bring?

Given the urgency and scale of the challenges associated with climate change, “we are seeing momentum in evaluating companies on their environmental impacts,” said D’Aurizio at HSBC Asset Management. There are two aspects: First, what are companies doing to minimize any negative impacts on the environment? Second — and this is where D’Aurizio is focused — what are companies doing to actively create a positive impact on the environment? “For us, this is especially exciting with our focus on companies tackling existing climate-transition trends,” he said.

As investors have become increasingly familiar with the underlying drivers for positive environmental outcomes, D’Aurizio finds that biodiversity, for example, has become a more prominent investment theme. Investment managers are rapidly responding to investor interest in such opportunities, and numerous strategies are emerging that allow institutional investors to participate in a biodiversity economy, such as natural capital, which incorporates forest conservation or regenerative farming; or blue-ocean investments, to name a few.

The transition to a net-zero economy continues to be the topic du jour for investors, D’Aurizio said. He expects that core focus will persist for some time, though social aspects such as diversity, equity and inclusion are also becoming part of the investment equation.

“HSBC Asset Management has long been committed to sustainable and responsible investing,” and was one of the first signatories to the U.N. Principles for Responsible Investment in 2006, D’Aurizio noted.

Source: ICE

A new economic model is emerging that values externalities and balances the world’s finite carbon budget to meet the 1.5-degree Celsius pathway that would limit global warming in the 21st century. This economic model is referred to as “carbonomics,” said ICE’s Bennett, and it underlies how and where investors are focusing their sustainability strategies.

Within carbonomics lies the “green premium,” which is the additional cost of adopting clean energy technology over traditional greenhouse gas-emitting energy sources. It illustrates how much more it costs to fund or use green technology versus technology based on fossil fuels. As greener technologies are newer, and incumbent technologies rely on processes like burning hydrocarbons, the green premium needs to be eroded or diminished to entice investors, Bennett said.

But there are many ways to incentivize investors. “It can come in the form of government support for risk investments,” he said, citing the Inflation Reduction Act of 2022 as an example. “The act stimulates investment in new technologies, whether it’s carbon capture or hydrogen, which can be done through tax credits and other incentives.” Essentially, by helping to derisk the investment profile, the government helps to reduce the green premium and reduce costs that might hinder investment.

ICE’s range of environmental-market components can help investors tip the balance of costs toward making more sustainable investments, Bennett said. “If you’re generating electricity from wind or solar, you get what’s called an ‘energy attribute certificate,’ which measures the positive externality of not polluting. But if you’re generating power from gas, for example, you don’t receive the extra revenue from the certificate and you also have to pay for the negative externality of your pollution by acquiring a carbon allowance,” he explained. “So you’re making one investment more profitable and the other less profitable. On that basis, you’re able to allocate capital to the more sustainable technologies.”

Read: Capitalizing on nature’s value for a net zero world

Vontobel’s Lenfers said institutional investors continue to look closely at climate change and the net-zero energy transition, especially in light of the spate of global weather extremes, droughts and floods. Vontobel approaches impact investments in two ways: by incorporating environmental and social challenges or opportunities as part of its broad investment strategy that fits into a global equity allocation; and by taking a more targeted or specific approach to climate strategy.

Whether through a broad or specific sustainability lens, Vontobel’s approach is to target a double dividend. “We believe [that] only if a company’s products and services are financially successful, they can have an impact in the real world. That’s also why we track a company’s performance and impact in depth and over time,” Lenfers said. “A snapshot of where it stands today doesn’t necessarily help us judge whether it has the potential to achieve impact and be financially successful in the long term.”

“To be very clear, we do not want to buy a company purely because it’s impactful when we are not convinced of its financial performance,” he added. And the same applies the other way around. “We always try to take a holistic view, to look at both sides of the coin, reflecting our aim to deliver on our double-dividend concept. Evidence in history shows that you do not have to sacrifice returns for doing good.”

Vontobel is seeing strong interest in its two impact equity strategies not only from institutional investors in Europe, which is often cited as the major hub for sustainability, but also in Asia and increasingly in North America, Lenfers said. Vontobel’s 2023 Impact Investing Survey showed that 71% of institutional investors aim to increase allocations in impact investing strategies over the next three years. Investors are also planning to do this across a larger number of asset classes. Listed equities were favored by 67% of investors; private equity by 49%; listed debt by 31%; private debt by 21%; infrastructure by 39%; and real estate by 26%.

Source: Vontobel original research, April/May 2023, based on survey of 193 respondents in Europe, Americas and Asia Pacific.

Sustainable investing requires data that is measurable, consistent and useful to asset owners in helping assess the ways that ESG factors have a material impact on performance. So far this has been lacking, but both industry providers and regulators are moving the needle in the right direction.

Several efforts are underway to ensure sustainability data is reliable and meets certain standards. ICE continues to work on expanding its data platform, “whether it’s around physical climate risk or temperature scores, monitoring how organizations are counting their greenhouse gas emissions and performing against their targets, or what their transition plans look like and how they are executed,” Bennett said. “Accessing these data sets together with the pricing data of ICE’s environmental market portfolio can help clients determine how investments should be valued through a sustainable lens.”

Read: Vontobel Impact Investing Survey 2023

Limited data availability and ways to measure positive impacts continue to be crucial hurdles for many institutional investors, said Lenfers at Vontobel. There’s no common database to measure impact, and much progress still needs to be made on data transparency, as “the level of transparency creates confidence,” he added.

For instance, one of the most commonly used pieces of data is the carbon footprint, which is “fairly standardized,” Lenfers said. “However, this doesn’t really tell you about the impact or about the positive benefit of a product or service. It just tells you how much carbon you are emitting during the production phase and during the product’s use.”

To illustrate the point, a wind turbine has a high-carbon footprint because it is built of energy-intensive materials, he said. But it produces power without emitting carbon dioxide, replacing carbon-intensive technologies typically based on gas or coal. And it’s relatively easy to calculate the impact in terms of potentially avoided carbon dioxide emissions.

“When it comes to other industries, such as microchips, which can be equally impactful, we often talk about enablers,” Lenfers said. These are technologies that help, for example, to increase the energy efficiency or smartness of various devices.

Over the years, cars, for instance, have been equipped with more semiconductors to optimize fuel efficiency and reduce emissions, among other benefits, he said, adding that today’s electric vehicles couldn’t function without them. This technology enables an efficient use of battery power and extends the range of an EV. The whole semiconductor industry is also making a huge effort to significantly cut the material and energy consumption involved in the manufacturing and running of its products.

To determine the impact of the different companies’ products and services, each investor “has to calculate the benefits and has to contact the companies that produce those products and services to request data and to advocate for transparency,” Lenfers said.

Vontobel focuses its engagement not only on ascertaining data, but also on having an impact on companies that face pressing environmental and social challenges. “We try to motivate companies to comply with and to sign up for science-based targets that can help get them to net-zero over time — with clear milestones. On the social side, diversity is one of our crucial topics, and we liaise with companies that we feel should do more on diversity,” Lenfers said.

“HSBC Asset Management is committed to offering sustainability-focused investments to meet investor demand,” D’Aurizio said. However, he emphasized, robust levels of continuous research, analysis, due diligence and engagement are required to effectively and credibly achieve positive impacts.

For example, the firm’s venture capital investment business supplements its extensive sustainability research by using third-party reporting sources to get closer to industry standardization and to help quantify the environmental and sustainable impacts of its investments, D’Aurizio said. “This helps us confirm environmental impact measures so that our investments meet certain environmental criteria and are meaningfully aligned to achieving at least one of the 17 U.N. sustainable development goals.”

Direct-engagement efforts are also a key component of the investment team’s positive-impact approach. “Because we are often investors with board participation, we can engage CEOs and founders of businesses on their sustainability performance and discuss how they can improve,” D’Aurizio said.

*United Nations’ Sustainable Development Goals
Source: HSBC Asset Management

As they consider and evaluate their ESG and sustainable investments, investors should be conscious of what they want to achieve and even consider setting formal objectives to ensure consistent comparisons.

D’Aurizio cautioned, however, that taking an overly narrow approach can be detrimental. “Focusing only on carbon reduction, for example, can mean missing out on exposure to companies that are achieving other equally important environmental objectives, such as promoting clean waterways. We have found that aligning to specific U.N. sustainable development goals allows for flexibility and progress in the multifaceted sustainable investing universe,” he said.

Asset managers agree that sustainable investing will be an integral part of the investment environment in the future. “Over the next five to 10 years, impact investing will be a core part of allocation for institutional investors,” said Lenfers at Vontobel. “There’s a strong need to incorporate social and environmental considerations in your portfolio from a risk perspective, but also from an opportunity perspective.”

In the longer term, adoption of sustainable investing, especially in relation to the climate transition, will become commonplace, and the tools for measuring positive impact will become ever more precise. “It’s not linear — it comes in fits and starts,” said D’Aurizio. “It’s not happening uniformly across all markets. But that is where we’re going globally, and it’s only a matter of time before we get there. As we progress in the journey of transformation, we will see increased capital flows to companies engaged in the net-zero transition and to climate technology companies.”

It is inevitable that carbon pricing will be embedded within the sustainable decision-making processes of all investors, according to ICE’s Bennett. “If in five years’ time we’re still talking about how we need to deploy carbon pricing, then we’re making it far more difficult to measure climate risk and reallocate capital effectively to deliver a net-zero pathway and have a sustainable planet,” he said. “We know what the issues are, and we have the solutions available now to start addressing them. We need to move on from the talking, target-setting and commitment-making to action and execution. It’s time to walk the walk.”