The United Nations Climate Change Conference in Warsaw showed us again how difficult it is to translate obvious facts into clear actions. The UN’s climate change report published at the end of October evaluated recent years’ climate change studies, and got to the heart of the issue. Despite all the controversies, scientists agree that there is no doubt that global warming has occurred over the past decades, and continues up to the present day. According to data produced by Global Footprint Network, we already consume resources equivalent to one-and-a-half times the planet Earth.
If resource consumption continues to rise as it has to date, humanity will require three-and-a-half Earths by 2050 to satisfy its hunger. However, we have only one planet, and we will not be receiving another. Although opinions about the extent and causes of the climate phenomenon continue to diverge, it is clear that economic growth, as we know it today, will reach its limit unless a radical change occurs in the way we operate and do business.
What is uncontested from a macroeconomic perspective, nevertheless frequently fails to be translated into microeconomic analysis. Investors focus too strongly on quarterly financial results. Sustainability issues such as climate change, demographic shift and resource scarcity are rejected as abstract scientific concerns. Yet they have a tangible relationship with how portfolio securities perform.
Global trends generate both opportunities and risks that have a real bearing not only on companies’ ecobalances – which many regard as notional and negligible – but also on their profits. Rising commodity prices, droughts and social conflicts have already had a strong impact on many companies in recent years; the introduction of resource-conserving technologies and a reorientation to the needs of an aging society have helped other companies to achieve faster growth. The foreseeable worsening of the resource problem means that corporate profits will depend to an ever-increasing extent on these global challenges. As financial market returns will also vary accordingly, investors can only be successful over the long term if such trends can be integrated into earnings estimates.
Doubters object that sustainable investment funds have only lived up to part of this promise to date. It is certainly the case that some academic studies conclude that, on average, investment funds which are described as sustainable fail to achieve continuous excess returns compared with conventional funds. These studies’ disappointing results nevertheless reflect the fact that apples are frequently compared with oranges when it comes to evaluating funds that are designated as sustainable.
Within the socially-responsible investment category, there exist a large number of differing approaches that cover a lot of needs. Although such sustainability analysis perspectives share many things in common – a long-term orientation and a comprehensive, interdisciplinary examination of ecological, social and economic factors – the motives are many: religious and ethical investors like to see their values reflected in their portfolios, foundations and charitable organisations are also keen to see their foundation or charity purposes pursued on the investment side, pension funds have fiduciary duties to fulfill, active investors aim to improve corporate management and governance, and investors in the public spotlight seek to avoid reputation risks. And while everyone aims to reduce risk and boost returns from the information garnered from sustainability analysis, conflicts of a not insignificant nature do arise about targets, depending on the underlying investment motive.
If funds are split according to investment motives, it is clear that ethically-oriented investors and investors who are concerned with avoiding reputation risks – who focus on excluding certain securities entirely from their investment universes – enter into very big negative bets, and forego opportunities in doing so. If a positive selection based on financially-material sustainability factors is pursued, however, studies show that potential returns grow considerably. If an excess return is to be achieved through utilising sustainability factors, the analytical approach must nevertheless be oriented consistently to this objective, and cannot cover all other aims credibly.
The realisation that sustainability analyses not only contribute to balanced global economic growth, but also generate excess returns, is becoming increasingly well-received. The United Nations launched its Principles for Responsible Investment (UN PRI) initiative in 2006. These are a collection of best practices to integrate environmental, social and corporate governance (ESG) factors into investment activities, with the aim of harmonising institutional investors’ fiduciary duties with sustainable global economic growth. The signatories to this initiative – foundations, pension funds and government funds – have meanwhile grown to almost 1,200, representing almost USD 35 trillion of assets under management. The market for sustainable investments offers massive potential, and is witnessing unbroken growth.
The doubters may also object that the market for sustainable investments is not worth anywhere near USD 35 trillion. Even in the broadly-sourced data of the Global Sustainable Investment Alliance – which include any investments with even the slightest of exclusion criteria – the market volume amounts to USD 13.5 trillion. In order to close this gap, and take the PRI signatories at their word, the initiative has developed a new reporting structure. The signatories will need to report in detail as to how they include sustainability criteria in their investment processes. The PRI estimates a tripling in the number of such reports.
With the coming of this hour of truth, we expect that demand for responsible investments will increase by leaps and bounds. In turn, as companies integrate sustainability into their investment processes, it will prompt them to manage and conduct their businesses more responsibly. It will be the broad acceptance of these principles – and resultant pressure from the capital market side – that will go further than any climate summit can do to place global economic growth on a sustainable footing over the coming years – including sustainable returns.