Unit 9: Responsible and Sustainable Investment PDF

367 |Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment INTRODUCTION LEARNING OBJECTIVES Investors – retail and institutional investors in public and On completion of this chapter, you will be...

367 |Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment INTRODUCTION LEARNING OBJECTIVES Investors – retail and institutional investors in public and On completion of this chapter, you will be able to: private markets - play a key role in allocating capital. To ensure a successful global transition to Net Zero, and understand the role of investment within the wider to enhance climate-resilient development, it is vital that financial system, and how investment impacts and is investors decarbonise portfolios and investment flows impacted by environmental and social sustainability to key sectors such as renewable energy and ‘green’ factors; building and transport. In addition, as we have seen describe different investment approaches and in earlier chapters, investment also needs to support products, their suitability for different types of sectors and firms as they transition from high-carbon to investors, and how they may support green and more sustainable business models. sustainable finance; Investment managers are an essential bridge between describe the growth in responsible and sustainable savers and businesses seeking finance; how they – and investment, and the reasons for this; you – invest matters. There has been substantial growth explain the differences and similarities between in sustainable investing in recent years, as the climate responsible and sustainable investing, ESG, impact crisis, climate risk and investment opportunities from investing and other related terms; the transition to a sustainable, low-carbon world have describe different types of investment funds and come into focus for all types of investors. Rapid growth explain how these may support investment in green increases the risk of greenwashing, however, and creates and sustainable finance; and other challenges for investors, investment managers and regulators. discuss the risks of greenwashing and other challenges to the growth of responsible and sustainable investing. 368 | Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment 9.1 INTRODUCTION TO INVESTMENT 9.1.1 Foundations of Investment High return Equity Before exploring sustainable investment, it is worth Alternative considering in brief the foundations of investing and investments investment management in general. The traditional approach to investment, applicable to both retail investors (non-professional individuals investing their savings) and institutional investors (professional investors Debt Real estate and investing on their own behalf, and/or pooling funds from tangible assets many individuals or entities and investing on their behalf) bases investment decision-making on: investors’ financial goals (e.g. ‘preserve capital’, ‘generate annual income’, ‘capital growth’); investors’ time horizons (e.g. short-term versus saving for retirement); and Money market and the level of risk investors are willing to take (e.g. low cash equivalents versus high risk appetite). A basic principle of investing is the risk/reward trade- off. That is, the greater the risk, the greater the potential Low return reward for an investor, as set out in the diagram opposite: Low risk High risk 369 | Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment As we will see in this chapter, as investors’ understanding of climate change and the physical and transition risks of QUICK QUESTION: HOW MIGHT THE RISKS AND climate change (which we covered in detail in Chapter 5) have developed, this has altered the risk/return profile OPPORTUNITIES FROM CLIMATE CHANGE IMPACT for many. In addition, for investors with longer time INVESTORS’ RISK/RETURN TRADE-OFFS? horizons, the mid-century Net Zero commitments made by many countries and organisations are also impacting Write your answer here before reading on. on the longer-term risk/return trade-off. The prospects of increased costs, significantly reduced demand, litigation risks and stranded assets increases the risks and decreases the likely returns from investments in high- carbon sectors and firms. Conversely, the opportunities from the transition to a sustainable, low-carbon world become more attractive to investors as the risks go down (as new technologies are proven, and the direction of regulation and policy becomes more certain) and the potential rewards go up. There are sound reasons, therefore, to invest in low- carbon assets (and divest from high-carbon assets) on purely risk/reward grounds, and this lies behind much of the recent growth in sustainable investment, as we will examine later in this chapter. As we will also explore, many investors also seek to achieve environmental or other sustainability returns alongside financial returns (often referred to as ‘impact investing’ and/or ‘values- based investing’). This is another factor driving the growth of the sustainable investment sector. 9.1.2 Asset Classes Individuals and institutions can invest in a very wide range of assets, which may be classified in a variety of different ways. For our purposes, we identify five main investment asset classes, some of which we have already covered in previous chapters. These are: 370 | Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment Equity: Owning a share (stock) of a company and partaking in any profits. Investors may purchase shares in a company directly, or through funds QUICK QUESTION: THINKING OF YOUR PERSONAL SAVINGS and other investment vehicles usually managed by AND INVESTMENTS, WHICH OF THE OPPOSITE ASSET CLASSES professional investment managers. DO YOU HOLD? HAVE YOU CONSIDERED ENVIRONMENTAL Debt (‘Fixed Income’): Lending money to a company, AND OTHER SUSTAINABILITY ISSUES WHEN MAKING YOUR government or other organisation and collecting interest. We looked at different types of green and INVESTMENT DECISIONS? sustainable loans and bonds, and green bond indices Write your answer here before reading on. and funds, in Chapter 7. Money market and cash equivalents: Holding cash across different currencies, or investments that are highly liquid and can be sold and converted to cash almost instantly. Real estate: Buying property, or investing in real estate funds that invest in residential and commercial property (as we have seen in earlier chapters, the construction and operation of buildings is a major source of greenhouse gas emissions). Alternative Investments: Investments that do not fall into any of the above categories, e.g. angel investing and venture capital, commodities, collectibles such as art, vintage cars, wine and cryptocurrencies (which we examine in Chapter 11). Retail and institutional investors often blend some or all of these different asset classes together to create an investment portfolio with a risk/return profile that suits their needs and preferences. In this chapter, we focus mainly on equity investment, but similar principles of green finance and sustainable investment can be applied to other asset classes, too. 371 | Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment 9.2 INTRODUCTION TO RESPONSIBLE AND investing/investment’ – that is, activities and strategies (social) and “G” (governance) factors are often interlinked SUSTAINABLE INVESTMENT that take into account investors’ beliefs, preferences and with these. values, including environmental, ethical, social and other 9.2.1 Definitions of Sustainable Investment factors, alongside their desire for a financial return. This ESG is generally seen as a ‘positive screening’ or In the context of green and sustainable finance, a wide approach to investing (and ‘ethical investment’, defined ‘inclusive screening’ approach to investing (see later in variety of terms including ‘ESG investment, ‘ethical on the next page) is not new; it dates back to at least the this section), as - usually - investments will be identified investment’, ‘impact investment’, ‘responsible investment, 1700s, when groups such as the Quakers established that exhibit favourable ESG factors such as those set ‘SRI investment’, and ‘values-based investing’ are in guidelines for banking and investment based on religious out previously. Some investment managers and funds common use. All describe investments and/or investment and philosophical principles. use ‘negative screening’ to exclude some sectors such approaches and strategies designed to deliver and as gambling, pornography, alcohol, and weaponry. As support positive environmental and social impacts (and/ An ‘Environmental, Social and Governance (ESG)’ we set out in Chapter 1, ESG approaches tend to focus or avoid negative impacts) as well as – usually - financial approach is intended to integrate these three factors into on how organisations incorporate these three factors. returns. Although the above terms are often used traditional financial analysis of investments. One or more A broader sustainability/sustainable finance approach interchangeably, there can be important differences ESG factors may increase the risk profile of an investment also needs to consider the economic, environmental between them, which we explore below. (for example, if assets are exposed to substantial climate and societal impacts – both positive and negative – of risks) or the potential returns on offer (for example, if an organisation’s activities, operations, and lending and For the purposes of this study guide, we will usually a company has developed a new, emissions-reducing investment decisions. Whilst many use the terms “ESG” refer to ‘sustainable investing/investment’ except technology). There is no single method for assessing ESG and “sustainable” interchangeably, this difference is where the context requires the use of a different term. factors, or for labelling an investment or fund as ‘ESG’, important, for it is the impacts we need to understand We generally use the term to refer to an approach to as we shall see in this chapter, but in general they might and measure when monitoring progress towards a more investing and investment decision-making that involves encompass one or more of the following factors: sustainable, low-carbon world. selecting investments that deliver positive environmental and social benefits and support the transition to Environmental factors: Energy use (and mix of A common criticism of the ESG approach is that there an environmentally and socially sustainable, low- renewable/non-renewable energy), emissions, can sometimes be more focus on the “G” (governance) - carbon world, combined with reducing or eliminating pollution and waste, impact on the climate and the than the “E” (environmental) and/or the “S” (social). This investments in harmful sectors and firms. The aim environment can lead to the seemingly perverse inclusion of major is to generate financial returns by reducing climate, Social factors: Human rights, equality, engagement greenhouse gas emitters (for example, airport operators) environmental and other sustainability risks and taking with and impact on communities, employee relations in ESG indices and funds because they score very highly advantage of the opportunities from the transition to in terms of governance – the lack of a common, agreed Governance factors: Quality of board and senior methodology for calculating ESG scores and ratings is a net zero, as well as delivering positive impacts for the management, shareholder rights, transparency and significant concern for investors, regulators and others. environment and/or society. This focus on impact – both disclosure. The development of taxonomies, and related regulatory in terms of investing for positive impact, and minimising negative impacts – is key. interventions (e.g. the development of fund labelling At the present time there tends to be a strong focus schemes linked to taxonomies) should help bring greater by many on the “E” (environmental factors), especially Another term often used to encompass sustainable clarity, consistency and comparability over time. climate-related risks and opportunities. As we have investment and related terms is ‘values-based explored elsewhere in this study guide, though, “S” 372 | Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment ‘Ethical investment’ is a catch-all term generally used to describe investments, or investment approaches and strategies, based on investors’ or investment managers’ QUICK QUESTION: HOW DO YOUR OWN ETHICAL AND ethical and philosophical beliefs. Whilst this may include ‘ESG’ and other forms of investment, and sustainability- PHILOSOPHICAL BELIEFS IMPACT YOUR OWN CHOICE OF focused retail investment funds can often be labelled INVESTMENTS (AND PRODUCTS AND SERVICES MORE as ‘ethical’ to avoid confusing potential customers with BROADLY)? ARE THERE ANY SECTORS OR COMPANIES YOU jargon, the term is better used to refer to investment AVOID – OR CHAMPION – ON ETHICAL GROUNDS? grounded in religious or other philosophical beliefs. This often involves the exclusion of certain sectors (‘negative Write your answer here before reading on. screening’) such as alcohol, tobacco and weapons, sometimes referred to as ‘sin stocks’; depending on the ethical beliefs involved, other sectors may be excluded, too. The Islamic investment platform Simply Ethical excludes investment in conventional financial services, for example, because charging and receiving interest is not permitted on religious grounds1. As with ESG labelling seen previously, there is no common, agreed definition or methodology for describing an investment or fund as ‘ethical’. Moreover, there is little prospect of this changing, as there are no plans for the development of ‘ethical taxonomies or the like; however, general regulations relating to the avoidance of mis-selling would usually apply to the use of the term ‘ethical’. 373 | Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment The term ‘Responsible investment’ was first adopted by students in North America and elsewhere in the Principles for Responsible Investment Develop an engagement capability (either directly 1960s and 1970s, in protest against universities investing 1. We will incorporate ESG issues into investment or through outsourcing) their endowments and pension funds in apartheid- analysis and decision-making processes. Participate in the development of policy, era South Africa. Today, the term is more commonly regulation, and standard setting (such as used to describe an approach to investment decision- Possible actions: promoting and protecting shareholder rights) making informed by and aligned with the UN Principles for Responsible Investment, introduced in earlier units Address ESG issues in investment Policy File shareholder resolutions consistent with long- - an active approach to incorporating ESG factors into statements term ESG considerations investment decision-making, strategies and engagement Support the development of ESG-related tools, Engage with companies on ESG issues with investors and investees, with a focus on impacts. metrics, and analyses It may be thought of as broadly synonymous with Participate in collaborative engagement “sustainable investment”. Assess the capabilities of internal investment initiatives managers to incorporate ESG issues Ask investment managers to undertake and Assess the capabilities of external investment report on ESG-related engagement. THE UN PRINCIPLES FOR RESPONSIBLE managers to incorporate ESG issues INVESTMENT 3. We will seek appropriate disclosure on ESG Ask investment service providers (such as financial issues by the entities in which we invest. The United Nations Environment Programme analysts, consultants, brokers, research firms or (UNEP) Finance Initiative and the United Nations rating companies) to integrate ESG factors into Possible actions: Global Compact established the Principles for evolving research and analysis Responsible Investment (PRI) in 2006, with the Ask for standardised reporting on ESG issues Encourage academic and other research on this goal of working with investors to support a more (using tools such as the Global Reporting theme sustainable global financial system. As of December Initiative) 2021, the Principles have some 4,600 signatories Advocate ESG training for investment Ask for ESG issues to be integrated within annual representing more than US $120 trillion in assets professionals. financial reports under management (AUM). 2. We will be active owners and incorporate ESG Ask for information from companies regarding The Principles are voluntary and aspirational, issues into our ownership policies and practices. the adoption of/adherence to relevant norms, offering a ‘menu’ of possible actions for standards, codes of conduct or international Possible actions: initiatives (such as the UN Global Compact) incorporating environmental, social and governance (ESG) factors into investment analysis and decision- Develop and disclose an active ownership policy Support shareholder initiatives and resolutions making. Signatories to the Principles publicly consistent with the Principles promoting ESG disclosure. commit to adopting and implementing them ‘where consistent with their fiduciary responsibilities’ (see Exercise voting rights or monitor compliance with 9.4.2). voting policy (if outsourced) 374 | Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment ‘Socially Responsible Investing/Investment (SRI)’ describes an active approach to investment and 4. We will promote acceptance and Collectively address relevant emerging issues investment decision-making involving the selection implementation of the Principles within the Develop or support appropriate collaborative or elimination of investments based on ethical investment industry. initiatives. guidelines and SRI ‘screens’ determined by the investor Possible actions: or investment manager, such as alcohol and tobacco, 6. We will each report on our activities and gambling, human rights and environmental impact. It is Include Principles-related requirements in progress towards implementing the Principles. comparable to ESG in many ways, although it tends to requests for proposals (RFPs) Possible actions: lack emphasis on governance or the ‘ethical investment’ Align investment mandates, monitoring approach described previously. Traditionally, SRI procedures, performance indicators and Disclose how ESG issues are integrated within approaches were based on ‘negative screening’, that is, incentive structures accordingly (for example, investment practices the avoidance and exclusion of shares, securities, funds ensure investment management processes and other assets that conflict with the investor’s beliefs Disclose active ownership activities (voting, reflect long-term time horizons when and personal values, where investors were often willing engagement and/or policy dialogue) appropriate) to accept lower returns. More recently, SRI approaches Disclose what is required from service providers have also adopted positive screening, seeking to identify Communicate ESG expectations to investment in relation to the Principles opportunities for investment, rather than investments to service providers avoid. Communicate with beneficiaries about ESG Revisit relationships with service providers that issues and the Principles fail to meet ESG expectations The objective of ‘impact investing/investment’ is to Report on progress and/or achievements relating achieve specific (usually) environmental and/or social Support the development of tools for to the Principles using a ‘Comply or Explain’ objectives, although the term could relate to any form benchmarking ESG integration approach of investing where there is a focus on non-financial Support regulatory or policy developments that Seek to determine the impact of the Principles outcomes alongside financial returns. When in its enable implementation of the Principles. infancy, impact investment was often conducted on Make use of reporting to raise awareness among a philanthropic basis, with investors more concerned 5. We will work together to enhance our a broader group of stakeholders. with environmental and social objectives than financial effectiveness in implementing the Principles. Source: Principles for Responsible Investment (2019) Principles For returns. Today, especially in the context of climate-related Responsible Investment (online). Available at: https://www.unpri. and environmental-related impact investing, this is often Possible actions: org/about-us/about-the-pri [Accessed: 22 January 2023] no longer the case. In fact, as alluded to previously, in order to meet the objectives of the Paris Agreement and Support/participate in networks and information other sustainability goals, all investment that seeks to platforms to share tools, pool resources, and align itself with these needs to understand and measure make use of investor reporting as a source of environmental and other sustainability impacts, both learning positive and negative. 375 | Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment One of the key characteristics of modern impact investment is that impacts must be measurable. A great deal of work has been done by the Global Impact QUICK QUESTION: WHAT ARE SOME OF THE MAIN Investing Network (GINN)2, the Impact Investing Institute3 and others in recent years to develop approaches SIMILARITIES AND DIFFERENCES UNDERPINNING THE and methodologies for identifying and measuring DIFFERENT TERMS DESCRIBED ABOVE? environmental and social impacts, some of which we Write your answer here before reading on. introduced in Chapter 4. GINN defines impact investment as ““Investments made with the intention to generate measurable social and environmental impact, alongside a financial return”, noting that an impact investment approach is often used to address environmental and social challenges in sectors such as agriculture, conservation, renewable energy and microfinance, and to ensure access to affordable basic services such as education, healthcare and housing. 376 | Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment 9.2.2 Sustainable Investment Strategies: From Light to generated from the prohibited activity (e.g. a retailer may Positive screening criteria vary widely, and may be Dark Green be included if less than 15% of its overall revenue comes applied at the sectoral level (for example, via a mandate In the preceding section, we described different from the sale of alcohol). These are known as ‘materiality to invest in renewable energy, clean transport and approaches to what can be described overall as thresholds’ or ‘acceptance levels’; they help investors and climate-resilient infrastructure) and/or the asset level. In ‘sustainable investment’. We also introduced terms such investment managers build diversified portfolios. the context of sustainable investment, ESG ratings and as ‘negative screening’ and ‘positive screening’, which are scores or other labels and certifications are often used Negative screening can (subject to materiality thresholds) to determine inclusion on the basis that these signal the used to describe different strategies used by investors ensure that investments avoid harmful sectors and positive environmental and/or social credentials of the and investment managers to select investments. In this activities, and therefore reduce exposure to climate, investment. The lack of a common, agreed methodology section, we introduce a range of strategies that can be environmental and other sustainability risks. They avoid for calculating ESG scores and ratings, however (there used to select investments and construct portfolios harm rather than seek to achieve positive environmental are more than 1,000 different ESG scores and ratings that meet sustainable investment criteria determined by and social returns. In doing so, however, they may miss available), makes it difficult for investors to compare investors and investment managers. These are presented opportunities to identify firms, sectors and activities that different potential investments. Furthermore, scores on a spectrum from ‘light green’ to ‘dark green’, with will benefit from the transition to a more sustainable and ratings that overweight governance factors may the latter representing the most complete and holistic world, and the financial and impact returns accruing from lead to investment in sectors or firms that damage the approach to sustainable investment. Adopting dark these. environment or society. green strategies can be very time and resource intensive, however, especially for individual investors. Investors and b. Light green: positive screening Following a survey of ESG ratings providers, users and investment managers may also adopt active or passive subjects, the International Organization of Securities investment strategies, or a combination of both. These The opposite of ‘negative screening’, ‘positive screening’ Commissions (IOSCO) identifies several issues with are discussed and contrasted in 9.3.4. refers to the inclusion of assets, companies or sectors ratings. Given their importance to investors and others, in an investment portfolio that meet pre-defined criteria a. Very light green: negative screening these require consideration. There is/are, in IOSCO’s view: determined by investors and/or investment managers. It is often used in conjunction with negative screening, Little clarity and alignment on definitions, including on As we saw previously, ‘negative screening’ refers to the so that – in the context of sustainable investment - what ratings are intended to measure exclusion of certain assets, companies or sectors from portfolios comprise investments that ‘do good’ and avoid an investment portfolio in accordance with pre-defined A lack of transparency about the methodologies investments that would have negative impacts on the criteria. Criteria are set by investors and/or investment underpinning ratings environment and society. Materiality thresholds may also managers in line with their ethical and religious beliefs, be used to help build diversified portfolios, in a manner Uneven sectoral and geographical coverage values, preferences and investment aims, but in the similar to that described above. By adopting a positive Concerns about the management of conflicts of context of sustainable investment negative screening screening approach, investors are more likely to benefit interest where ESG ratings providers also perform usually means the exclusion of environmentally and from investments in firms, sectors and activities that consulting services for companies that are the subject socially harmful sectors such as oil and gas, alcohol, will benefit from the transition to a more sustainable of ratings gambling and pornography. Negative screening does world, as they avoid climate, environmental and other not necessarily mean that prohibited activities are The need for better communication with companies sustainability risks. completely excluded from a fund or portfolio; generally, that are the subject of ESG ratings, given the assets may be included if less than 15% of revenues are importance of ensuring these are based on sound information4. 377 | Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment IOSCO recommends that regulators should consider whether the introduction of regulatory oversight might bring greater consistency to ESG ratings. In addition, QUICK QUESTION: THINKING OF YOUR PERSONAL SAVINGS ESG ratings providers should improve transparency, disclosure, and any potential conflicts of interest. AND INVESTMENTS, DO YOU CONDUCT ANY INFORMAL OR FORMAL NEGATIVE OR POSITIVE SCREENING? WHAT SECTORS DO YOU TRY TO AVOID AND/OR INVEST IN? Write your answer here before reading on. 378 | Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment c. Green: active ESG investing To overcome some of the drawbacks of a positive The SFDR introduces three main disclosure According to research by Morningstar, however, screening approach relying on ESG scores and ratings, requirements for financial providers and advisers: nearly one quarter of “Article 8” funds should not, in investors and investment managers can adopt a more their view, be labelled as promoting sustainability 1. An adverse impact statement, which sets out because they follow a negative screening approach active investment strategy. This might involve a “best- how a firm considers the negative impacts of in class” approach, where funds and portfolios are rather than positively screening for or selecting investments on 64 environmental and social investments that deliver environmental and/or built from assets with only the highest ESG scores and sustainability indicators (18 are mandatory, 46 ratings in each sector (e.g. the highest 10%). This may social outcomes5. This suggests that there is still are voluntary) much to be done to improve transparency and help overcome some of the drawbacks of such scores and ratings described previously and filter out less 2. A description of how a firm integrates its avoid greenwashing. environmentally and socially sustainable activities and assessment of sustainability (ESG) risks in its Source: European Commission (2022). Available at: https:// firms. investment strategies and decision-making ec.europa.eu/info/business-economy-euro/banking-and- processes (including how remuneration and finance/sustainable-finance/sustainability-related-disclosure- In addition, investors and investment managers may incentives are linked to this) financial-services-sector_en [Accessed: 22 January 2023] supplement ESG scores and ratings with their own Morningstar (2022). Available at: https://www.bloomberg. 3. A classification of funds into one of three com/news/articles/2022-08-18/-esg-stripped-from-23-of-eu- (or independent) analysis of potential investments’ categories (Article 6, 8 or 9), depending on the sustainable-funds-in-fresh-review [Accessed: 22 January 2023] environmental and social impacts – both positive and extent to which sustainability is a consideration negative. This is costly and time-intensive, however, and is therefore most relevant to large institutional investors Article 6 funds are those that do not have with the resources to undertake such analysis. investment objectives related to sustainability d. Dark green: impact investing (ESG) factors. Firms and advisers are still required to disclose how sustainability risks are considered, As we described previously, impact investing requires READING: SUSTAINABLE FINANCE DISCLOSURES however, as set out above. measurable environmental and/or social returns REGULATION – ARTICLE 8 V ARTICLE 9 alongside financial returns, but where such returns can Article 8 funds are those that seek to promote be identified, measured and reported, thereby giving In 2023, the European Commission’s Sustainable environmental and/or social sustainability investors greater confidence in the environmental and Finance Disclosures Regulation (SFDR) will come into characteristics, although these are not core social performance of investments. Rather than rely on effect. Part of the Commission’s Sustainable Finance objectives. Fund managers will tend to follow a the ESG scores and ratings developed by others, impact Action Plan, a key aim of the SFDR is to prevent positive screening/ESG investing approach, and investors and investment managers seek to identify, greenwashing by introducing new transparency and hence Article 8 funds are referred to as “light green”. understand and measure the environmental and social disclosure requirements for financial firms providing benefits of their investments. or advising on investment and mutual funds, UCITS Article 9 funds have environmental and/or social and pensions. The new rules will apply to all firms sustainability factors as core objectives, and are operating in the EU, and to firms marketing their referred to as “dark green” – i.e. they adopt an products, services and advice in the EU. impact investing approach. 379 | Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment As we discussed in Chapter 4, however, impact with mandates to engage in active stewardship of measurement can be complex, challenging, time- the investments in their portfolio(s), or individuals estimates that the nearly 170 major emitters consuming and resource intensive, and is therefore or other entities, such as NGOs, who seek change for engaged with account for some 80% of total global likely to be undertaken only by specialist and/or environmental or other ethical reasons – often referred industrial emissions. large institutional investors. Bodies such as the new to as “shareholder activism”. International Sustainability Standards Board (ISSB) Why was Climate Action 100+ formed? and, previously, the Carbon Disclosure Standards Investors of all types have always sought to influence In 2015, nearly 200 countries signed the Paris Board (CDSB) and Carbon Disclosure Project (CDP), the strategic direction of the assets and companies they Agreement, which aims to keep the increase in seek to standardise the measurement of greenhouse own, but increasingly, engagement includes sustainability global average temperature to well below 2oC above gas emissions, whereas the measurement of social considerations; for example, seeking to influence a pre-industrial levels. The investor signatories of and other sustainability returns is supported by the company’s environmental policies, corporate culture, Climate Action 100+ believe that engaging and Impact Reporting and Investment Standards (IRIS) governance structure, diversity and inclusion or strategy, working with the companies in which they invest – developed by the Global Impact Investment Network and leadership overall. This may be driven by a sense of to secure greater disclosure of climate change risks (GIIN). This sets out 16 impact categories, aligned with environmental activism, by investors’ desire to encourage and robust company strategies aligned with the the UN Sustainable Development Goals. The IRIS+ Core companies to better identify and manage climate, Paris Agreement – is consistent with their fiduciary Metrics provide consistent and comparable data for environmental and social sustainability risks, by a belief duty, and is essential to achieving the goals of the assessing the environmental and broader sustainability that better returns can be gained by aligning a company’s Paris Agreement. impacts of investments6. The Impact Investing Institute strategy and activities with sustainability objectives, or by has produced a range of useful learning materials a combination of these. Climate Action 100+ is designed to implement the for investors and others on impact measurement, investor commitment first set out in the Global management and reporting. As they state, though: “Please Investor Statement on Climate Change in the CASE STUDY: CLIMATE ACTION 100+ bear in mind that there is no single good way to measure months leading up to the adoption of the Paris impact – there are many helpful approaches, processes and What is Climate Action 100+? Agreement: “As institutional investors and consistent frameworks, but no silver bullet. It is important to measure with our fiduciary duty to our beneficiaries, we will: … Climate Action 100+ is an initiative led by major impact well, but almost impossible to measure it perfectly. work with the companies in which we invest to ensure institutional investors to engage systemically Aim for good.” 7 that they are minimising and disclosing the risks and important greenhouse gas emitters and other companies across the global economy that have maximising the opportunities presented by climate e. Very dark green: investor engagement and activism change and climate policy.” significant opportunities to drive the clean energy Arguably, the deepest green investment strategy is transition and help achieve the goals of the What are investors asking focus companies to do? to engage with the Boards and senior managers of Paris Agreement. Investors actively engage with organisations to seek change. All shareholders are part companies to improve governance on climate Investors signed on to Climate Action 100+ are owners of the firms and other assets they invest in, and change, curb emissions, and strengthen climate- requesting that boards and senior management of can use their rights to influence change by exercising (or related financial disclosures. companies: threatening to exercise) their voting rights. Shareholders include large asset managers or institutional investors To date (March 2022), Climate Action 100+ has been joined by 615 institutional investors. The initiative 380 | Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment The growth in disclosure on environmental and other sustainability factors, prompted by regulators and bodies 1. implement a strong governance framework that such as Climate Action 100+, the PRI, and the UN-convened Net Zero Asset Owners Alliance and Net Zero Asset clearly articulates the board’s accountability Managers Initiative (introduced in Chapter 3), seems likely to encourage increased levels of activism and engagement and oversight of climate change risks and from individuals, NGOs and institutional investors as companies’ strategies, activities, operations and exposure to opportunities; environmental and social factors become more widely known. There are a wide range of sustainability-related issues 2. take action to reduce greenhouse gas emissions on which investors should seek to engage the boards and senior management of companies. These include, but are not across the value chain, consistent with the Paris limited, to: Agreement’s goal of limiting global average a firm’s overall business strategy, and the activities and operations supporting this, and the extent to which this takes temperature increases to well below 2oC above account of the transition to a sustainable, low-carbon world; pre-industrial levels; and the impacts of physical, transition and liability risks; 3. provide enhanced corporate disclosure in line with the recommendations of the TCFD and other the quality, consistency and comparability of sustainability disclosures, so that investors can understand the positive applicable frameworks to enable investors to and negative impacts of their investments (and, in the case of institutional investors, disclose their own financed assess the robustness of companies’ business emissions and other sustainability impacts); plans against a range of climate scenarios and whether there is a credible, Paris-aligned transition plan for firms that are currently significant emitters of greenhouse improve investment decision-making. gases, consistent with the Science-based Targets or other relevant framework; Why do investors choose engagement? the capability and competence of the Board and senior management in respect of climate change and other sustainability issues, and the capability and competence of the firm overall in implementing its sustainability Global collaborative investor engagement sends strategies; and a powerful signal – directly to companies – that investors are asking for and expect companies whether board and senior management incentives are linked to sustainability targets. to respond to climate change. Climate change is a systemic risk – one that investors cannot diversify away from. As equity investors and universal owners, investors have the ability and the responsibility to address climate risks and seek greater disclosure on how the most systemically significant emitters are aligning with the 2oC transition and disclosing climate change risks and opportunities to the market. Source: Climate Action 100 + (2020): http://www. climateaction100.org/ [Accessed: 22 January 2023] 381 | Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment In practice, many investors and investment managers CASE STUDY: ENGINE NO.1 AND EXXONMOBIL combine the sustainable investment strategies outlined previously, or aspects of them, in their investment ExxonMobil is a multinational oil and gas corporation, and the world’s fifth largest emitter of greenhouse gases. decision-making, and fund and portfolio construction. It has also been – at least in recent years - one of the worst performing energy companies in terms of delivering This can involve, for example, an initial positive screening returns to investors, underperforming its peers. approach to identify a broad universe of potential investments, followed by a deeper analysis of a smaller In May 2021, a small activist hedge fund called Engine No.1 used its small shareholding (just 0.02% of selection of these. For investment advisers and managers ExxonMobil’s shares) to try to change ExxonMobil’s strategy. It used its position as a shareholder to convince in particular, the choice of sustainable investment much larger investors, including BlackRock, Vanguard and StateStreet (who together owned some 20% of strategy will depend on the characteristics, preferences, ExxonMobil’s shares), to support its call for change. Delivering an 83-page presentation at ExxonMobil’s 2021 values and desired outcomes of clients and investors. AGM, Engine No.1 told shareholders that: Where those are more closely associated with seeking ExxonMobil had significantly underperformed relative to its peers; positive environmental and social returns, deeper green strategies may be adopted. Where investors’ preferences it had failed to adjust its strategy to enhance long-term value; are influenced more by seeking to avoid climate and its focus on chasing production growth over value had resulted in an undisciplined capital allocation strategy broader sustainability risks, lighter green screening and had destroyed value; strategies might be more apparent. As discussed, much also depends on investors’ and investment a refusal to accept that fossil fuel demand could decline in the future had led to a failure to take even initial managers’ resources, skills and time, as the analysis and steps towards addressing this, and managing the impacts of climate risks; and engagement required for deeper green strategies is the lack of a successful transformation on the board had left ExxonMobil unprepared, and threatened substantial. continued long-term value destruction8. The presentation convinced shareholders to overturn the recommendations of the existing ExxonMobil board and to replace three existing directors with individuals with backgrounds in renewable energy. This, they hope, will position ExxonMobil in a much better position to reduce emissions, manage climate risks and the transition to Net Zero, and deliver long-term returns for investors. Source: Engine No.1, (2021) Reenergize ExxonMobil // Investor Presentation (online). Available at: https://reenergizexom.com/materials/ shareholder-materials/ [Accessed: 22 January 2023] and author’s own materials 382 | Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment 9.2.3 Sustainable Investment Themes READING: QUINTET PRIVATE BANK Thematic investing is an investment strategy that tries to identify long-term changes and trends and seeks to James Purcell, Group Head of ESG, Sustainable and Impact for Swiss-based Quintet Private Bank, shares his approach understand how these will impact firms, sectors and to investment strategy. He explains how he builds different strategies, such as Leader and Improver portfolios, using a the economy overall. As we have seen throughout this range of different techniques. study guide, climate change, and broader environmental and social sustainability factors, will impact all economic “Sustainable investing is far from binary; it is a powerful toolkit with which to build a portfolio. Just like how a activities and entities, and particularly sectors such as conventional investor may blend growth and value strategies to create a portfolio that harvests different risk agriculture, energy, infrastructure and transport. The premia, a sustainable investor can combine sustainable leaders, improvers, themes, and dedicated assets to physical, transition and liability risks of climate change build a multi-asset portfolio with sustainability as a driver of returns. will substantially increase costs and reduce returns from Leader strategies invest in those companies that are already performing strongly on sustainability matters those sectors and firms most exposed to these, and – such companies often bring defensive characteristics to a portfolio. Improver strategies seek to identify asset stranding will reduce investment values, potentially companies that are making progress on the sustainability journey, as companies get better at managing their to zero in some cases. Some sectors and firms will benefit sustainability factors they de-risk, lowering their cost of capital and improving the predictability of their cash from the transition to a more sustainable, low-carbon flows. world, generating long-term financial returns alongside positive environmental and other sustainability benefits. Improver strategies diversify the traditional Leader approach. Thematic strategies focus on the technologies A recent joint study by UNEP and the University of Oxford, and services of the future economy. This differs from Leaders and Improvers that place greater emphasis on for example, identified five major sustainable investment corporate practices. Thematic strategies often bring a strong growth component to a portfolio. themes for the future: Finally, dedicated assets are investments that are designed explicitly with sustainability as a defining Green Energy: Investments in green energy can characteristic. Some, such as green bonds, are excellent replacements for conventional assets classes – in deliver high economic multipliers, have high potential this case, EUR and USD investment grade credit. Others, such as microfinance, can bring decorrelation and to crowd in private investment, and are an important diversification. step on the road to economy- wide decarbonisation. In totality, sustainability can be deployed as a powerful toolkit, rich in narrative, and with a number of risk Green Transport: Compared with traditional drivers and sources of return.” alternatives, green transport investments can create many jobs quickly, while also creating long-term jobs Source: Hannah Duncan: Interview with James Purcell for the 2021 Chartered Banker Institute edition of this study guide in asset operations and management. They can also deliver high economic multipliers. 383 | Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment Green Building Upgrades and Energy Efficiency: Lower for Longer: Low investment returns could make When effectively targeted, green building upgrades it challenging for some investors to increase their and energy efficiency improvements may be among commitment to sustainable investment if there is an the most effective economic stimulus tools available to expectation or even a perception that there is a return policy makers. trade-off. Investments in sectors such as renewable Natural Capital: Economies are reliant on the natural energy, energy efficiency and resource scarcity may world, and with large portions of natural capital under benefit, however, from the search for higher returns. threat from deforestation or natural disasters, it is Purposeful Capitalism: Investors are increasingly now more important than ever that policymakers take becoming more proactive in seeking environmental decisive action to protect and rebuild it. and social returns alongside financial returns. In Green Research and Development: While the addition, regulators have increased their focus on this. characteristics of research and development Climate Energy: As carbon pricing and other policy investment programmes differ from those of the other and regulatory drivers develop, investors will move key policy areas, supporting these is crucial for the away from increasingly unattractive carbon-intensive long-term health of economies and for our ability to companies towards lower-carbon alternatives. address climate change9. Social Status: It will become a source of Similarly, the CFA Institute (2020) identified six key trends embarrassment to be unsustainable, and will be which, in its view, will underpin the future of sustainable harder to hide the negative environmental and social investment; rather than taking a sectoral approach, impacts of business, as disclosure and reporting though, it focused on global demographics: become more widely used, more transparent and more easily accessed and shared10. FinTech Disruption: The use of FinTech tools and techniques (see Chapter 11) can support sustainable investment through enhanced availability and analysis of unstructured data, especially related to impact. This enables investors to have more customised sustainability objectives, uncover new investment opportunities, and measure impacts more accurately. Parallel Worlds: The growing inclination of consumers to express their preferences and values in their consumption decisions will extend into personalisation related to sustainable investment. We may also see more evidence of activists seeking to promote environmental and social change. 384 | Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment 9.2.4 Growth of Sustainable Investment In recent years, sustainable investment has gained QUICK QUESTION: WHAT THEMES DO YOU BELIEVE WILL substantial momentum in both retail and institutional HAVE THE GREATEST IMPACT ON THE GLOBAL ECONOMY markets. According to the Global Sustainable Investment Alliance, sustainable investment totalled $35.3 trillion in AND INVESTMENT? HOW WILL THESE IMPACT YOUR OWN 2020, an increase of 15% over the two-year period since SAVINGS AND INVESTMENT DECISIONS? 2018. Sustainable investment assets under management accounted for nearly 36% of total global assets under Write your answer here before reading on. management (an increase from approximately 33.5% in 2018)11. Growth continued during 2021, although inflows into sustainable investment funds slowed in the second half of the year, according to Morningstar. Globally, more than 1,000 funds were launched or repurposed as “sustainable” during 202112. On the demand side, interest in sustainable investing among the general population of investors increased significantly: from 71% in 2015 to 85% in 2019, and in millennial investors from 84% in 2015 to 95% in 2019, according to the Morgan Stanley Institute for Sustainable Investing13. At the institutional level, a study by Cambridge Associates found that the number of institutional investors globally reporting the adoption of sustainable and impact investment strategies had grown by 146% between 2016 and 2020, with particularly marked growth in the UK and Europe - 250% - between 2018 and 202014. Signatories to the UN Principles for Responsible Investment (PRI) commit to incorporating sustainable investment strategies in their investment decision-making. According to the 2021 PRI Annual Report, 95% of the growing number (more than 4,600) of PRI signatories in listed equity markets, 94% in fixed income markets and 92% in private equity markets reported they incorporated ESG factors into investment decision-making15. 385 | Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment In 2018, seven major groups working with investors i. Risk increased costs of liability risks arising from harmful (including the PRI, Carbon Disclosure Project (CDP) and environmental impacts, and other higher regulatory the UNEP Finance Initiative (UNEP FI)) launched the As we have discussed in earlier chapters, there is now a costs; Investor Agenda to better coordinate the growing range much greater understanding, appreciation and disclosure of climate risks (physical, transition and liability risks) the introduction of realistic carbon pricing – the of investor initiatives, to support institutional investors introduction of globally consistent carbon pricing of tackling climate change, and to showcase the actions and a growing understanding of broader environmental and sustainability risks. Production or supply chain around $75 per tonne, as recommended by the IMF; some investors are already taking to improve their climate-related decision-making and risk reporting16. The disruptions caused by the physical impacts of climate changing consumer preferences leading to a Investor Agenda aims to encourage other institutional change lead to increased costs for firms, or increased substantial decrease in demand for high-carbon and investors, asset owners and managers and pension funds, investment in climate-resilient infrastructure and other unsustainable products and services; by means of peer pressure and the sharing of good transport networks. Changing consumer preferences, heightened reputational risk; and practice, to scale up their sustainable investments to help alternative low-carbon business models and technologies, and evolving regulation to support countries’ and the significant asset impairment and stranding. As we have support the transition to a low-carbon world. Its work global transition to Net Zero increase the transition discussed in previous chapters, limiting emissions to covers four thematic areas: risks faced by many businesses. Firms in high-carbon, restrict global warming to below 2oC would leave the Investment: managing systemic climate risks in high-emission sectors, and other sectors with a harmful majority of current oil, gas and coal assets stranded. investor portfolios and supporting the transition by impact on the environment or society, face increased Sustainable investment strategies can successfully shifting capital to value-creating businesses set to costs from litigation and other liability risks. mitigate against such risks, and there is evidence that succeed in a net-zero future. The Economist Intelligence Unit estimates that the this is happening. A Morgan Stanley report (2021), Policy Advocacy: advocating for policies aligned with negative impact of climate change on global assets for example, concluded that sustainable investment delivering a just transition to a net-zero economy by under management is $4.2 trillion in present value, and contained less risk, regardless of asset class, compared 2050 or sooner. will be $43 trillion by 210018. The Cambridge Institute with ‘traditional’ alternatives. Sustainable investments Corporate Engagement: engaging companies to drive for Sustainability Leadership has estimated that the were also more resilient against market downturns and and demonstrate real progress in line with a 1.5oC effects of climate change on investments could lead to recessions, at least in the US: during 2008, 2009 and future. reductions of up to 45% of the value of global equity 2015, traditional funds in the US were much more likely portfolios, and of up to 23% losses in fixed income (debt) to report a loss than sustainable funds. Sustainable Investor Disclosure: enhancing investor disclosure to investments were also found to perform better than help stakeholders track investor action in line with a portfolios19. There are a wide range of impacts that could have significant effects on investments at the sector, their traditional counterparts during the initial phase 1.5oC pathway17. of the COVID-19 pandemic, due to their lower exposure regional, country and/or firm and asset levels, including: There are many interlinked factors that combine to drive to carbon risk when demand for oil fell substantially the growth of sustainable investment, including changing increased costs of physical risks associated with in 202020. It seems likely that more recent geopolitical demographics, and changing consumer and investor climate change, including the increased frequency and events, which have led to sharp rises in oil and gas prices, values and preferences, which we will discuss further on. severity of extreme weather events. As we will see in will reverse this trend, at least in the short-term. Three key drivers, however, are the “3 Rs”: risk, regulation Chapter 10, economic losses from such events have and returns, which we examine next. risen substantially over the past 30 years, with losses in some recent years significantly higher still; 386 | Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment ii. Regulation risk management systems and investment due Both the impact of existing regulation and the prospect diligence processes, and disclosure will be significantly of further policy and regulatory interventions (such as In earlier chapters, we examined the emergence and strengthened. the introduction of more robust, global carbon pricing) development of policy and regulation to lead and support drive the growth of sustainable investment. Regulation the transition to a more sustainable, low-carbon world. National regulators in Europe are also taking similar can increase the direct costs of holding high-carbon and As we have seen, to date much of this has been focused approaches; German regulator BaFin, for example, other unsustainable assets, whilst the realistic prospect on addressing climate change, with the Paris Agreement is expected to introduce rules in 2022 to prevent of future regulation increases transition risks. (2015) supported by an increasing range of policy greenwashing by requiring investment funds that interventions at the global, regional (e.g. EU) and national describe themselves as ‘sustainable’ or similar to invest levels. a minimum of 75% of their assets sustainably, or track a CASE STUDY: UK FINANCIAL CONDUCT recognised ESG market index 23. French financial regulator AUTHORITY – ESG & SUSTAINABLE INVESTMENT In financial services, regulatory priorities have focused on AMF has announced that sustainable finance, and in FUNDS: IMPROVING QUALITY AND CLARITY the identification, measurement and disclosure of climate particular addressing the risks of greenwashing, will be risks, although central banks and financial regulators are priorities in 202224. In July 2021, the UK Financial Conduct Authority now beginning to consider broader environmental and (FCA) released new guidance for investment funds social sustainability factors,as well. In addition, regulators, In the UK, amongst other regulatory developments, describing themselves as ‘sustainable’ or ‘ESG’. particularly in the UK and Europe, are increasingly the mandates of the Bank of England, the Prudential Noting the substantial increase in retail investor taking active steps to support market integrity and Regulation Authority and the Financial Conduct Authority demand for such funds, and a corresponding rise avoid greenwashing and mis-selling by introducing new were revised in 2021 to include addressing climate in applications for authorisation, the FCA wrote regulations on disclosure, and the labelling of funds and change. The Pensions Act was amended in the same to investment managers to stress that funds investments. Since 2020, the European Securities and year to include mandatory requirements for climate marketed with a sustainability and ESG focus Markets Authority (ESMA) has been required to take change governance and reporting, aligned with the should describe their investment strategies clearly, sustainability and ESG factors into account in its rulebook recommendations of the TCFD. And, as set out in the case and any assertions made about their goals must and supervisory activities. A new European Sustainable study opposite, the UK’s Financial Conduct Authority has be reasonable and substantiated. Furthermore, Finance Disclosure Regulation (SFDR) came into effect released new guidance for investment funds to ensure the FCA noted that a number of applications for in March 2021; it requires disclosures of climate risks market integrity and avoid potential greenwashing. authorisation had been poorly drafted and fell and other environmental and social factors21. The EU below expectations – they often contained claims Commission also plans to introduce new sustainable In the US, the Securities and Exchange Commission about sustainable credentials and impact that did finance regulations that would amend MiFID II (the (SEC) has announced mandatory rules for climate risk not bear scrutiny. Markets in Financial Instruments Directive) and other EU disclosures, aligned with the recommendations of the legislation governing investments. These are expected TCFD25. In addition, the SEC is considering guidance Concerned about market integrity and the potential to be introduced in 202222. They will require providers for investment funds that describe themselves as effects of misleading claims on consumers, the to incorporate sustainability factors into assessments ‘sustainable’ or ‘ESG’ similar to that being developed and FCA has developed a set of guiding principles for of clients’ investment needs and preferences, with implemented in the UK and Europe. the design, delivery and disclosure of responsible reference to the EU Taxonomy. In addition, sustainability and sustainable investment funds. If consumers factors must be integrated in investment managers’ understand the basis on which sustainability claims 387 | Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment are being made by fund and investment managers, Principle 2. The delivery of ESG investment funds and can monitor whether these claims are genuine, and ongoing monitoring of holdings this should – in the FCA’s view - improve the The resources (including skills, experience, functioning of the market. It should also reduce the technology, research, data and analytical tools) risk that retail investors are buying products that that a firm applies in pursuit of a fund’s stated ESG do not meet their needs, and should create greater objectives should be appropriate. The way that a trust in funds described as ‘sustainable’ or ‘ESG’. fund’s ESG investment strategy is implemented, and the profile of its holdings, should be consistent with The FCA’s guiding principles comprise one its disclosed objectives on an ongoing basis. overarching principle and three supporting principles that focus on ‘design’, ‘delivery’ and Principle 3. Pre-contractual and ongoing periodic ‘disclosure’. disclosures on responsible or sustainable investment funds should be easily available to Overarching principle: Consistency consumers and contain information that helps A fund’s ESG/sustainability focus should be them make investment decisions reflected consistently in its design, delivery and ESG/sustainability-related information in a key disclosure. A fund’s focus on ESG/sustainability investor information document should be easily should be reflected consistently in its name, its available and clear, succinct and comprehensible, stated objectives, its documented investment policy avoiding the use of jargon and technical terms and strategy, and its holdings. The principle is when everyday words can be used instead. Funds accompanied by a set of ‘key considerations’, which should disclose information to enable consumers add clarity and more detail as to how the principle to make an informed judgment about the merits of can be met in practice. investing in a fund. Periodic fund disclosures should Principle 1. The design of responsible or include evaluation against stated ESG/sustainability sustainable investment funds and disclosure of characteristics, themes or outcomes, as well as key design elements in fund documentation evidence of actions taken in pursuit of the fund’s stated aims. References to ESG (or related terms) in a fund’s name, financial promotions or fund documentation Source: Financial Conduct Authority (2021) Guiding principles on should fairly reflect the materiality of ESG/ design, delivery and disclosure of ESG and sustainable investment sustainability considerations to the objectives and/ funds (online). Available at: https://www.fca.org.uk/news/news- stories/guiding-principles-on-design-delivery-disclosure-esg- or investment policy and strategy of the fund. sustainable-investment-funds [Accessed: 22 January 2023] 388 | Principles and Practice of Green and Sustainable Finance Unit 9: Responsible and Sustainable Investment iii. Returns Ultimately, the key driver of investment decision-making QUICK QUESTION: WHAT REGULATORY DEVELOPMENTS for most investors and investment managers is financial, HAVE BEEN RECENTLY ANNOUNCED IN THE MARKET i.e. the expectation of achieving a market or above- WHERE YOU LIVE AND WORK, OR A MARKET YOU ARE market return. If sustainable investment strategies FAMILIAR WITH? generate such returns, then regardless of investors’ preferences and values we should expect inflows to Write your answer here before reading on. sustainable investments and funds. Historically, the consensus view was that sustainable investment led to a trade-off between financial and environmental and social returns. Companies that ‘do good’ did not also ‘do well’. Evidence is increasingly emerging, though, that sustainable investments at least match, and in some case outperform their traditional counterparts: In 2015, a substantial meta-study by researchers at the University of Hamburg and Deutsche Asset Management concluded that there was a positive correlation between ESG investing and financial performance26. Khan, Serafeim and Yoon (2016) studied the performance of US-listed companies listed on the MSCI KLD index (which tracks exposure to companies with positive ESG ratings) across a 21-year period from 1992 to 2013, finding that firms with higher ratings on material sustainability issues demonstrated better performance than companies with inferior ratings on the same issues27. A recent study (Berchicci and King, 2021) seeking to replicate results demonstrated, however, that these seemed to have been caused by a statistical error, and the study’s conclusions should not be relied on