February 26, 2021
Sustainable investing is no longer just a buzzword. Over the past few years, investor and consumer focus has zeroed in on a company’s ESG—its environmental, social and governance factor. Investors want their money to contribute to a higher goal than the bottom line, and they are demanding that companies take a much more holistic view of their business than they have in the past. Sustainable investing is a result of this growing sentiment; to take BlackRock’s definition, sustainable investing is:
“…about investing in progress, and recognizing that companies solving the world’s biggest challenges can be best positioned to grow. It is about pioneering better ways of doing business, and creating the momentum to encourage more and more people to opt-in to the future we’re working to create.”
Sustainable investing (synonymously called impact investing) has more than doubled in the last seven years. In 2012, global sustainable investments amounted to about $13.3 trillion. In 2018, that number had jumped to $30.7 trillion. Over the next decade and a half, that number is expected to reach $150 trillion.
What are the reasons behind sustainable investing becoming the fastest growing investment trend in recent history? Generally, money follows demand and as investor demand for sustainability grows, so does the availability of impact investing funds. Additionally, there are now studies showing that sustainable investors aren’t hurting their returns by demanding more ESG focus—in fact, many companies that shifted their focus to a triple bottom line are doing better than they ever did before. The US has had to rush to catch up to other countries in the ESG space but is growing faster than ever to stay in line with the global standard. Let’s look at each of these reasons in detail:
Younger generation investors have established that they are committed to investing in companies that make sustainability a core part of their business operations and values. As a result, sustainable investing is growing in popularity as the next generation amasses assets and becomes a considerable force in the investment realm. Depending on the milestones they are trying to reach as they grow their financial portfolios, investors may increase the percentage allotment to sustainable investments in their portfolio. To read more about asset allocations and how seasoned investors decide what to invest in, click here.
To put it in perspective, 31 percent of millennial investors either usually or always consider environmental, social or governance (ESG) factors in their investing. That is more than double the percentage of baby boomers. Additionally, 66% of female investors said socially responsible investing will become more important to their portfolios. With women and younger generations holding a greater proportion of assets and becoming the ‘majority’ investor, views on traditional versus sustainable investing are changing.
There is growing recognition that ESG research and analysis can potentially identify investment risks and generate excess returns.
A perfect example of this is LEGO, who ended their partnership with Shell Oil in 2014 and now partners with companies like the World Wildlife Foundation on social initiatives. The company is also working toward having 100% renewable energy capacity by the year 2030 while committing to reduce its overall carbon footprint. For sustainable investors, this is a sign that the company is investing for growth with a long term focus.
The chart below shows LEGO revenue year over year:
Its decision to be more sustainable in 2014 does not seem to have hurt LEGO. In fact, 2015 saw the biggest percentage increase in sales in the company’s history.
A Harvard University study found that companies with good ratings on sustainability issues most relevant to their industries significantly outperformed companies with poor ratings in socially responsible investing. For example, companies which embrace low-carbon technology are more likely to be future-proofed and companies which treat their employees fairly are more likely to have consistent cash flows, according to an article by Morningstar. Trends like these speak to the growth of sustainable investing now and in the near future.
From 2012 to 2018, Japan’s investment in sustainability was up 200x. And while the US is catching up in the growth of sustainable investing options, Europe leads the race with $2 trillion more sustainable investments. The UK specifically aims to be net-zero on greenhouse gas emissions by 2050. In France, investors now have to include a section on how ESG impacts their investment strategies.
Sustainable investing still has room to grow. Of the 10 most sustainable companies with over $1 billion in revenue, only one is based in the US. The company that tops this list is Chr. Hansen Holding, a bioscience corporation based out of Denmark. Not only does the company focus on natural solutions for preserving foods and protecting crops, it also goes against the norm on a few other factors: Nearly 30% of its board is made up of women, according to the Corporate Knights study, and its CEO’s salary is about 24 times that of an average worker with the firm. In the US, CEOs made 287 times more money than their workers did in 2018. The sustainable investing world is rapidly expanding to include these metrics into its criteria. Diversity in leadership teams and boards, along with the salary differentials between leaders and workers, are just two of these metrics.
These values reflect those of the younger, more diverse investors that are now able to enter the market. Eventually—not too far in the future—sustainable investing will become the mainstream narrative of all investing.
Mutual funds and ETFs focused on sustainable investing have to compete in the stock market and must meet investor criterias for risk and return in order to be viable. According to a 2018 study, people who consider themselves expert or advanced investors said they were investing an average of 42% of their portfolio in sustainable investments and expected an annual return on their entire investment portfolio of 10.9%, on average. That compares with 32% and 8.8%, respectively, for those people who consider themselves beginner investors. Seasoned investors usually look for long term growth trends and analyze a company’s fundamentals before making decisions, which bodes well for the rise of sustainable investing. A portfolio mix of sustainable investments and REITs can provide people who are investing for growth with consistent, competitive returns.
The benefits of sustainability have been proven academically. According to research by Deutsche Bank, which evaluated 56 academic studies, companies with high ratings for environmental, social, and governance (ESG) factors have a lower cost of debt and equity; 89% of the studies they reviewed show that companies with high ESG ratings outperform the market in the medium (three to five years) and long (five to ten years) term. The rise of sustainable investing will lead more companies to publish their ESG ratings and allow greater analysis on how these metrics impact investor value, debt, capital, earnings, and the bottom line.
The sustainable investing sphere has grown rapidly to accommodate demand from investors, including more younger adults and women. With less skepticism around returns from funds investing in sustainable organizations, along with lower fees, a growing number of individual and institutional investors are defaulting to sustainable investing. Socially responsible investing is no longer just a fad, but instead is a new framework for business and investment. Finally, with the US racing to catch up with the move to sustainable investing in other parts of the world when it comes to issues like climate change and gender equality, the sustainable investments class is going to be bigger over the coming years.