Sustainable money is showing UP! With the global investment funds balance tipped to shift to sustainable by 2025, the funding landscape is changing at such a pace, it feels positively old fashioned even mentioning it wasn't a thing until recently. Sustainable investing has come a long way. Fast.
AFTER YEARS OF RELUCTANCE TO SUPPORT SUSTAINABLE INVESTMENT, WE HAVE PASSED THE TIPPING POINT AND SUSTAINABLE INVESTMENT IS 'SUDDENLY' ON.
In the Morningstar chart shown above you can see that in 2020 we woke up and more than 1/4 of assets under management globally are already flowing to sustainable investments. This essentially means they are invested according environmental, social, and governance (ESG) factors.
So how does a fund decide if an investment is sustainable? There are really no institutional investors not committed to sustainable investing and the attention is not shifting from 'if' to 'how'. With increasing momentum - techniques and tools used for decisioning in sustainable investing have had to step up in a hurry. In the past, most of the tools used were 'negative screening'. In the absence of company declarations about their ESG obligations - or even the detail of their business and its environmental and societal impact, this was all we had. Of course that has all changed and ESG reporting is increasingly either a legal requirement or openly declared. (There is nothing quite like the making reporting a condition of investment to spur interest in transparency.)
While institutional investors define and track progress against clear metrics and targets for their sustainable strategies. It is important to check your own alignment as your fund may or may not be as vested and aligned with your own personal priorities. Some targets have to do with their own activities: for example, the proportion of their portfolio managed with respect to ESG factors. (In some asset classes such as government bonds, sustainable practices are less developed and may thus take more time to apply than in asset classes such as public equities.) Others might consist of goals for the ESG performance of portfolio companies, such as reductions in carbon emissions.
So while a sustainable investment strategy consists of familiar blocks: a balance between risk and return and a thesis about which factors strongly influence corporate financial performance, just like your own lifestyle priorities, it is worth digging further to ensure your goals are shared. And it's becoming easier to do just that.
McKinsey recently published this little matrix which gives a handy explanation. According to McKinsey, institutional investors use at least one of three techniques to integrate ESG factors in portfolio construction and management.
• Avoid material environmental, social, and governance (ESG) risks or comply with values-based investment thesis
• Exclude particular companies or sectors from investment universe based on ESG concerns
• Acknowledge potential positive correlation between ESG quality and returns
• Integrate financial implications of ESG factors in research and analysis
• Weight fund toward holdings with higher ESG quality
•Identify ESG as a lever for value creation
• Pursue improvements in a company’s ESG< performance by engaging with board or management
EXAMPLES OF APPLICATION
• Exclusion of companies for such reasons as:
• Noncompliance with values chosen by the government or fund
• Recommendations by ESG team
• Additional qualitative analysis of ESG risks
• Investment managers include ESG factors in fundamental analysis
• Investments concentrate on specific sustainability themes (eg, green bonds, clean tech, low carbon)
• Dialogue and involvement with enterprises in which investors hold significant stakes and see potential to create value by improving ESG performance (eg, by increasing energy efficiency)
Flows are estimated for sustainable open-end funds and ETFs available to U.S. investors. The group includes equity, fixed-income, allocation, and alternatives funds that represent themselves to be sustainable investments. Often called ESG funds, environmental, social, and governance concerns are central to their investment process, and this is clearly apparent from reading the "principal investment strategies" section of their prospectuses.
Chart: Morningstar. Data as of 31 December 2020. Includes sustainable Funds as defined in Sustainable Funds US Landscape Report, Feb 2020. Includes funds that have been liquidated; does not include funds of funds.