Sustainable investing has become mainstream worldwide, with research suggesting that $22.8tr – about a quarter of the money under professional management – is invested in assets that incorporate socially responsible or environmental goals as well as a financial return.
Those objectives are increasingly being pursued by institutional investors for their potential to manage risk and ensure long-term returns, against an unstable global backdrop of widening inequality, environmental degradation and poor corporate governance.
But ethical goals are also rapidly becoming an important consideration, particularly among young investors.
A report from Morgan Stanley last year showed that millennials are twice as likely as the overall investor population to put their money into companies with social or environmental strategies.
The shift in mindset is gathering momentum – according to the latest report from the Global Sustainable Investment Alliance (GSIA), assets being professionally managed under responsible investment strategies jumped by 25% between 2014 and 2016.
Morgan Stanley believes that sustainable investing assets are growing at a compound annual growth rate of nearly 12%.
It found that 84% of asset owners polled in a survey last year were at least “actively considering” integrating environmental, social and governance (ESG) criteria into their investment decisions, while half of those had already taken the step.
There is ample evidence of the trend.
Since its founding in 2006, the United Nations Principles for Responsible Investing (PRI) has attracted support from more than 1 800 signatories, who represented $68tr in assets under management as of April 2007.
Larry Fink, the CEO of BlackRock, the world’s largest asset manager, told the Financial Times in October that sustainable investing would be a core component of “how everyone invests in the future” and that it intended to become a global leader in the field.
At the same time the firm launched a number of ESG-screened exchange-traded funds (ETFs).
Fink said he expected that investment in ETFs with a sustainability focus would rise from $25bn to $400bn within a decade.
Credit rating agencies have begun to take note – earlier this month Fitch launched a new integrated scoring system showing how ESG factors impact its individual credit rating decisions.
The agency said it was introducing ESG Relevance Scores across all asset classes, starting with more than 1 500 non-financial corporate ratings.
Initial results showed that 22% of Fitch’s current corporate ratings were influenced by at least one ESG factor, it added.
The dominant sustainable investment strategy globally is negative or exclusionary screening, which avoids investments that generate revenue from objectable activities or sectors, like firearms, tobacco, pornography or even fossil fuels.
Geographical location can also be a factor.
According to the GSIA report, negative screening accounted for $15.02tr of its estimated sustainable investment assets, followed by ESG integration with $10.37tr, and a mix of corporate engagement and shareholder action with $8.37tr.
Impact investing, which targets a specific social or environmental goal, is a much smaller segment of the market, but is also growing rapidly. A report released by PRI last year estimated that more than 450 investors allocated $1.3tr to impact investments worldwide in 2016.
The market for sustainable investing is very young – the Morgan Stanley survey showed that 60% of the asset managers incorporating ESG into their investment process only began to do so in the past four years, and 37% within the last two.
The view that incorporating ESG factors into investments will hurt financial performance is now outdated, although it remains prevalent among individual investors with less exposure to the research.
A number of studies have shown that companies with robust ESG practices have a lower cost of capital, lower share price volatility, and fewer instances of bribery, corruption and fraud over a given time period.
Companies that perform poorly on ESG have a higher cost of capital and their share prices are more volatile due to controversies and incidents like oil spills, labour strikes and fraud.
High ESG-rated companies were more competitive and generated abnormal returns, often leading to higher profitability and dividend payments, according to research from MSCI, a global provider of equity, fixed income and hedge fund stock market indices.
It points out that modern investors may also re-evaluate traditional investment approaches because of global sustainability challenges such as flood risk and sea level rise, privacy and data security, demographic shifts, and regulatory pressures – developments which were all introducing new risk factors.
Nonetheless, proof of market-related performance is the biggest challenge to the adoption of sustainable investing, followed by the absence of ESG data, the supply of quality managers and strategies, and general lack of knowledge about the industry, the Morgan Stanley survey shows.
Mariam Isa is a freelance journalist who came to SA in 2000 as chief financial correspondent for Reuters news agency after working in the Middle East, the UK and Sweden, covering topics ranging from war to oil, as well as politics and economics. She joined Business Day as economics editor in 2007 and left in 2014 to write on a wider range of subjects for several publications in SA and in the UK.