2020 – The Year of Sustainable Finance?
Charlie Reading, MD and Founder of Efficient Portfolio explores the concept behind sustainable finance and what 2020 holds for it.
There was once a time that investors were only interested in one thing, profit and achieving a return on investment. In the past, this has seen many investors making money from unscrupulous means. Investing, even unwittingly, in companies or stocks linked to arms, tobacco, big pharma or similar questionable operations seemed just another way to make money but as the world wakes up to a sea change in terms of environmental and ethical investing, there has been a rise in the past few years of ethical, or what some are dubbing ‘sustainable’ finance.
Whilst it would not be prudent to try and compare the returns from the ‘old stock’, such as tobacco, alcohol and arms, with the new green kids on the block, many experts are suggesting that ethical investing is on the brink of something big. The suggestion across the board is that investors are finding that if they are good to the planet and to people, they also end up, on average, benefiting themselves.
There is mounting evidence that funds which observe environmental, social and governance standards in their strategies tend to outperform those that don’t by a significant margin.
Could 2020 be the year we see this kind of thinking take ahold? Only time will tell, but what has been happening so far?
What is sustainable finance?
According to the Global Sustainable Investment Alliance (GSIA), an umbrella group, around $23trn, or 26% of all assets under management in 2016, were in ‘socially responsible investments’ that take account of environmental, social and governance (ESG) issues.
The actual definition of sustainable finance differs on who you ask. For some, it simply comes down to what most would term routine or ‘normal’ investments. There exists a certain group of companies and investments that are separated into what the GSIA term ‘negative screening’ which are considered unethical or untrusted.
The other definition is, of course, those that actively create a positive change in the world. These have been referred to in recent times as ‘impact investments’ meaning that in these situations, a precise impact can be quantified and measured.
The International Energy Agency estimates that $75 trillion in cumulative investment directed mostly towards renewable and other low carbon energy technologies, as well as energy efficiency measures, is required to keep global temperature rise to below 2C and avoid the worst effects of global warming.
This all adds up to a long-term strategy that matches the hopes that the global industry has for such finance initiatives to make a real difference.
An immediate example of this could be the reduction in the amount of carbon dioxide emitted by a production facility or manufacturing plant or the amount of education delivered to underfunded or poverty-stricken schools in a developing country as a result of a particular project. Although quite different from traditional ways of measuring investment success, this presumes that financial return does not need to be sacrificed to also enjoy non-financial goals.
For example, The International Energy Agency estimates that $75 trillion in cumulative investment directed mostly towards renewable and other low carbon energy technologies, as well as energy efficiency measures, is required to keep global temperature rise to below 2C and avoid the worst effects of global warming.
The sheer scale of capital required for this shift is beyond the scope of public finance alone, meaning that private finance will be essential to the low carbon transition.
What kind of options are there?
Before we jump headlong into 2020, it is important to note that sustainable finance can increase investment risk, and can potentially reduce the investment returns. By limiting investments to only ethically-focused companies, investors are limiting the pool of investments that can be selected from.
That said, since the UN Principles for Responsible Investment were introduced in 2006, investors have started to see the likes of the Vanguard Group and Fidelity Investments increasingly offering ethical investing; a trend which doesn’t show signs of slowing. Guido Fürer, the Chief Investment Officer for Swiss Re, has also said that it is ‘doing good’, and that it ‘makes economic sense’.
Investment Managers, PortfolioMetrix, have also added a selection of Ethical Portfolios as part of their offering. This means that investors can maintain the same risk level as they do with their portfolios, the only difference being that the underlying holdings will then meet the criteria for an ethical portfolio.
Where some may be mistaken though, is that this isn’t an all or nothing choice. Moving entire portfolios over to ethical ones might be rather risky, but you could, for example, move your ISAs to a more ethical approach, whilst leaving your pension in the more traditional investments. However, this is an area that is important to research and know well before committing.
In terms of where people might invest, the choice here is huge and is improving all the time. As the world becomes more socially-aware and green movements such as Extinction Rebellion and the work of green activists such as Greta Thunberg are recognised, more investors care about where their capital is sunk into.
Sustainable finance takes many forms, but here are a few examples that 2020 might see heralded as the norm from now on:
Social Business: While this is nothing new, this kind of sustainable finance refers to businesses who not only turn a profit but also have social issues at their heart. Profits are invested back into the business in order to combat exclusion, protect the environment or promote development and solidarity. They can take many forms, all of which you can expect to see more of throughout 2020, namely:
- Social Impact Bonds (SIB): Bonds that are repaid to investors once a project’s social objectives are met.
- Microfinance: A solution that opens up credit to more disadvantaged populations.
- Impact Investing: Putting one’s savings in companies with a strong social or environmental impact.
Green Finance: Sometimes regarded as an arm of SRI, it combines those financial transactions that favour the energy transition and fight against climate change. A relatively new phenomenon, the market is expected to exceed a value of $100 billion dollars a year by next year. One of its main tools is green bonds, issued with the aim of financing ecological initiatives. Decarbonising investor portfolios by financing companies that limit their ecological footprint is also proving popular within this sphere.
Social Finance: This option has already seen savings and assets invested in valuable social finance products. Representing €10 billion in France in 2016, the sector offers funding to projects that do not fit into classic financing circuits, such as businesses tied to employment, social and housing, international solidarity and the environment. In France, the specialised organisation Finansol certifies certain social finance products (including SRI products) and monitors trends in social finance.