Why sustainable investing is smart investing

From the investor’s perspective, it makes absolute sense to invest in the companies and industries aligned with a sustainable vision of our world, says Jessica Robinson

The concept of sustainable investing has been around for quite some time. However, for many, it has taken a long time for the penny to drop – but today more and more people are realising that we can use our wealth, through our investment decisions, to bring about positive change in the world.

The momentum behind sustainable investing has been slowly gathering over the last couple of years. In fact, 2022 may well be the year that sustainable investing comes of age. With the world still reeling from the Covid-19 pandemic and the climate crisis becoming increasingly apparent, people are thinking about the impact of their investment decisions – on society, on the environment and on the communities in which we live. But sustainable investing is no longer seen as a nice-to-have. Sustainable investing is now seen as smart investing – as a way to build the kind of future that we want for people and our planet.

What exactly is sustainable investing?

What are we talking about? Sustainable investing is an investment discipline that considers environmental, social, and corporate governance (ESG) criteria to generate long-term competitive financial returns and positive societal impact. Various other terms are often used such as responsible investing, impact investing or ethical investing – while there are nuanced differences, it’s fair to say that the commonality is to achieve positive change, invariably with a social or environmental dimension.

However, sustainable investing isn’t just about avoiding investing in companies that do harm. There is a new class of investors actively seeking out companies that address daunting social and environmental challenges while also delivering financial returns. These companies fall into a wide range of industries and sectors – ranging from food to transportation, from healthcare to education – the universe for sustainable investors is extensive.

Capitalism and our changing expectations

In recent times there has been a great deal of discussion over the role of capitalism and the systems it creates, some asking if capitalism is, in fact, in need of saving from itself. This shift in thinking is challenging many of the assumptions we have made, with more and more people posing questions like how can the reckless, unbridled and extremely damaging behaviour of some companies go unchecked? And whether we could reset the private sector and our expectations of companies to, as a result, push business to be a powerful tool for social good?

This is where investors – both institutional and retail – come into play. Seeking to change corporate behaviour. But sustainable investing is also about being a smart investor, in particular investing in what we want our future to look like.

Take, for example, the global policy agenda which is shaping the that way many investors are thinking. The Paris Agreement on climate change gave us a global carbon budget, and we are seeing widespread climate commitments being made by corporates and investors alike. Over the last year, we have seen more and more countries and corporates make net-zero commitments and this will undeniably shape what our future landscape.

Look at the Sustainable Development Goals – these are the closest thing we have to a global strategy, essentially setting out what we want the world to look like in 2030. From the investor’s perspective, it makes absolute sense to invest in the companies and industries aligned with this vision of our world.

The elephant in the room

Despite the common sense and logic behind investing sustainably and responsibly, we have often been distracted by the controversial debate on whether being a sustainable investor results in lower financial returns. Many people still ask ‘doesn’t doing good result in making less?’

Critics argue that limiting your investment portfolio by excluding certain companies that don’t show ‘good conduct and an adherence to certain values’ might result in leaving out some reliable performers (e.g. from the fossil fuel industry, tobacco firms and so on). They will argue that you will give up some financial performance if you put your money into a sustainable or impact investment product.

Those on the other side counter-argue that a portfolio of companies scoring high on sustainability metrics are much more likely to do well in the long run because they are better at managing risks. We do now know that non-financial factors provide important signals about future financial performance. If you are thinking through the different environmental and social issues that could impact on a company, these are likely to provide early warning signals that would not necessarily be reflected in its stock prices or financial statements.

Historically, one of the challenges we faced was the lack of data to demonstrate and support the argument that investing sustainably does not result in lower financial returns. However, the good news is that this has changed – now we have more and more concrete evidence on how sustainable funds outperform the wider market, countering claims that sustainable investment comes at the expense of performance.

A growing market

As this evidence has grown so too has momentum – with more investors claiming sustainable investing is the future, and fund companies launching sustainable funds at record pace. A pivotal moment happened in early 2020, when investment heavy weight Larry Fink famously stated that Blackrock would put sustainability at the centre of its investment strategy.

Most big investors now believe sustainable investing is good risk management, leveraging the practice to help manage risk in uncertain times. The challenges of 2020 and 2021 have been somewhat of a game changer in this regard. As the pandemic swept the world, many sustainable investors held their breath, collectively fearful of what it would mean for its impressive trajectory. But the worse did not happen – in fact, it turns out that companies that manage sustainable risks better, manage other risks better as well. The downturn associated with the pandemic has thrown water in the face of naysayers claiming that sustainable investing would result in lower returns – this is simply not true.

Where next?

What will happen next? Thankfully it seems that the pandemic has strengthened investors’ commitment, with demand for sustainable and green products continuing to grow. As we look ahead, certain themes within the sustainable investing universe will gain more attention. Climate change will remain a top priority for many investors. Coming off the back of COP26 at the end of last year, the summit has driven new and improved climate commitments, with companies and investors following suit. Diversity has been gaining attention for a few years, but the Black Lives Matter movement has brought into sharper focus the lack of meaningful progress. And of course, the pandemic also shone a spotlight on social issues, pushing many investors to reconsider management of social risks within their portfolios.

There are still challenges to overcome to embed sustainable investing as the ‘new norm’. Disclosure and data remain thorny issues, with concern that data is still fragmented, disclosure is inconsistent, and the lack of standardisation holds investors back. We still have some way to go on the regulatory front too – while the European Union has been a front runner with its sustainable finance agenda, there are some delays as well as ongoing debates.

Despite these challenges, we have many reasons for optimism. Perhaps one of the most exciting trends is how retail investors are waking up to the sustainable investing trend. Interestingly, research tells us that a lot of this drive is coming from women as well as younger generations. New audiences and new conversations are to be had – and this is the intention of my new book, Financial Feminism: A Woman’s Guide to Investing for a Sustainable Future. For me, 2022 presents the opportunity to take sustainable investing to many more people so that the penny can drop for others too.