A senior Swiss banking figure examines different ways of thinking through sustainable investing and what are the qualities it should have to be worthy of the name.
It has been a wild year for sustainable investing or more broadly investing done under the rubric of Environmental, Social and Governance values. No doubt 2020 and the start of a new decade will bring in tougher reporting rules for companies and funds on their ESG claims and more scrutiny from well intentioned but wary investors. Taking stock of all this, we asked Norbert Ruecker, head of economics and next generation research at Julius Baer to look at the pitfalls and the promise of sustainable investment approaches and explain the basics of what belongs under the umbrella of ESG. The usual editorial disclaimers apply but the editors here are grateful to the author for an explanation of the issues. To comment, email email@example.com and firstname.lastname@example.org
The popularity of sustainable investing stems in part from the aspiration to make a positive contribution to society. We care about our footprint, we are conscious of what we consume, and we increasingly also aim to align our investments with these considerations. However, while we widely assume that we ‘do good’ by investing sustainably, there is comparably little analysis available investigating this idea. In fact, the existing academic literature shows only limited evidence that sustainable investing has a positive social or environmental impact (1).
This inconvenient finding raises questions around some of the zeitgeist thinking. What does the measurement of the carbon footprint of an investment portfolio tell us, if it is not linked to emissions in the real world? What does the divestment of assets achieve, if the overall impact is negligible? How relevant is the footprint of your investments compared with that of your consumption? Are exclusions a ‘feel good’ rather than a ’do good’ strategy? While these questions sound harsh, we do believe that we should provide honest answers. The investment world is becoming overwhelmed with the idea of sustainability and purpose, and having an objective perspective is increasingly difficult but also more and more necessary.
Promises and pitfalls
Sustainable finance has moved from niche to mainstream. Its popularity masks the fact that ‘doing good’ is anything but easy.
Sustainable investing examines companies from an ESG perspective, ie, investments are focused on companies with a corporate culture that is based on having a long-term view and responsibility towards all stakeholders. In this case, sustainability originates bottom-up from the companies’ practices. This strategy has many similarities with a quality investment style. The evidence is overwhelming that sustainable investing offers superior risk-adjusted returns and thus caters particularly well to long-term, buy-and-hold investors. The offering in this area is very broad and covers equities, bonds and parts of the alternative investment asset class and related products, enabling investors to build a diversified portfolio.
Within sustainable investing, we believe it is important to put a special emphasis on thematic investing, where the United Nations Sustainable Development Goals serve as a compass and common language in the identification of companies where sustainability originates from the business itself. Themes could include, for example, health, nutrition, low carbon and water. In terms of ESG ratings, companies could be considered sustainable because of the nature of their business, even if the company’s ESG score is only average relative to its peers.
Exclusions of certain businesses based on ethical considerations is a common and popular aspect of sustainable investing. Importantly, there is a difference between values-based exclusion and the regulatory need to prohibit investments in controversial weapons.
In comparison, impact investing aims to generate a positive social or environmental impact. Impact investments are satellite investments and this strategy particularly caters for those investing with a purpose beyond financial returns and who would like to have a positive effect on people’s lives. While the intentions are honorable, this strategy has its pitfalls. Impact investing requires sufficient common ground between the investor and the investment provider on values, agreement on the goals and meaningful measurement of the consequences of the investments, which usually all prove to be relatively complex. Impact investing is done through either engagement as a shareholder or the direct financing of companies or projects. The offering is thus comparably limited and includes bonds and parts of the alternatives asset class such as private equity.