The desire for sustainability is changing the way we live, but how will this affect the way we invest our money and pensions? Welcome to the world of sustainable finance.
Environmental, social, and governance (ESG) issues have grown to dominate many investment decisions in recent years. Simply put, this means placing your money where it will make the world a better place. That’s exactly what sustainable finance is about!
Sustainable investing encompasses a wide range of activities, from investing in green energy projects to investing in companies that demonstrate social values like social inclusion or good governance, such as having more women on their boards. Sustainable finance may assist the world transition to net zero emissions by channeling private money into carbon-neutral projects, as claimed by the European Union, whose Green Deal Investment Plan intends to raise $1.14 trillion to help pay for Europe's net zero climate change emissions by 2050. To ensure that sustainable investments deliver on their promises, the International Financial Reporting Standards Foundation has just established the International Sustainability Standards Board, which will develop new regulations to evaluate sustainability claims.
In addition to benefiting the environment and making the society more equitable and inclusive, evidence is emerging that sustainable firms provide higher returns to the investors. Between 1970 and 2014, a study conducted for asset manager, Fidelity, tracked the performance of a variety of ESG investments around the world and discovered that half of them beat the market. Only 11% demonstrated poor performance. According to BlackRock, the world's largest asset management firm, more than eight out of ten sustainable investment funds outperformed non-ESG-based share portfolios during the peak of the COVID-19 pandemic in 2020!
Based on the research by financial website Morningstar, companies with high ESG ratings have seen larger growth in their share price over the last five years besides delivering higher dividends to the shareholders. This is significant because the majority of stock market investments are made by financial organizations such as pension funds. In the United States, entities that manage other people's money own about 80% of listed equity in prominent corporations.
Individuals may choose to receive a lesser rate of return in order to save the environment, but institutional investors and pension fund trustees do not have that option. They are obliged to follow a fiduciary duty to behave in accordance with the best financial interests of the investors. However, increased returns on sustainable assets imply that trustees no longer have to choose between sustainability and profit. As stated in the World Economic Forum's Transformational Investment report, the trustees of New Zealand's state pension fund argued that climate change threatened their ability to fund pensions and therefore, they moved on to a sustainable financing approach. Since its inception in 2003, the fund has outperformed comparable investments by 1.24% per year, a difference of $7.24 billion.
But why do ESG-friendly investing outperform traditional investments?
Consumer attitudes are shifting, which is one factor. As explained by a study conducted in the United States, two-thirds of customers of all ages prefer to buy from companies that reflect their beliefs. This figure jumps to 83% among millennials (those aged between 18 to 34). According to a global poll, consumers are four to six times more inclined to buy from a firm that has a corporate purpose which they support. However, if a firm does anything with which they disagree, three-quarters said that they stopped buying from that brand and even pushed others to do the same.
Carbon-intensive industries such as coal, oil, and gas are also finding it difficult and costly to acquire finance, as major lenders refuse to do business with them. As reported by a McKinsey study, sustainable businesses are more likely to win contracts, save money by using fewer resources, have less regulation, retain the best people, and avoid losing money on outmoded carbon-intensive processes.
According to Bloomberg, the total value of ESG investments is on its course to hit $53 trillion by 2025, accounting for more than one third of all worldwide assets!
To conclude, finance can help direct investments to sustainable businesses and initiatives, thereby accelerating the transition to a low-carbon, circular economy. So all in all, sustainable finance takes into account how finance i.e., investing and lending, interact with the economic, social and environmental challenges of the everyday world.