Earning market-rate financial returns and dividends remain priorities for investors, but that isn’t their only goal. From global institutions to individuals, investors these days seek to align their decisions with the ESG values of companies. They want to have more responsible investment options with morality as a core consideration. This value-based investing, popularly called sustainable investing, is rapidly gaining traction.
While considering this instrument, investors factor in both long-term profits and implications of their investments on society.
As drivers of social change, the choices are seldom ever in conflict with their conscience. Thus we’re seeing an uptick of sustainable investing products presented by fund managers, who are able to meet those demands.
What is sustainable investing?
So what has brought about this wave of socially responsible investment based on ethical values? Investors now want to pull their heads out of the sand and understand the true impact of their investments on the environment and society at large.
Sustainability includes resilient investors who integrate environmental, social and governance factors into their portfolio to improve returns and reduce risk.
For an informed investor, environmental concerns like waste management, water scarcity, biodiversity, lowering emissions and going paperless are non-negotiable.
Social issues such as human rights, labour standards, gender and diversity and community relations are no less significant.
And if good governance fosters sustainability, then a clean slate on corruption, executive compensation and whistle-blower schemes matter significantly.
The enlightened investor wants to be part of the business’ evolution and, in a way, influence the organisation’s culture.
The underlying theme in sustainability is the three pillars: People, Planet and Profit.
Why is sustainable investing important?
Profit, of course, is why businesses exist. That said, investors have started to realise that profits must be complemented with a vision.
Let’s start with climate changes that can disrupt food and water systems as a consequence of heatwaves, floods and drought. Naturally, these factors will impact the cost of water and food across the globe, impacting each one of us.
As global citizens, investors believe they have an obligation to combat extreme weather scenarios by making sound investment choices. Thus we see scores of investors eliminating coal and fossil fuels from their stock choices as they don’t meet their ethical criteria.
It explains why the push for a low-carbon economy is gaining momentum.
Social factors to impact a company’s performance. Negativity breeds among stakeholders if an organisation has a poor safety record, deals in “harmful” products like tobacco, alcohol, arms production, or is known for oppressive labour practices, workers’ strikes and a history of consumer protests. These sensitive factors can affect its bottom line.
In the 1990s, reports emerged of how sportswear giant Nike employed minors to stitch soccer balls and made them work overtime. The backlash against Nike was such that sales took a hit and the company was forced to change its supply-line policies.
Also, it is generally seen that companies that reduce exposure to geopolitical conflicts in their supply chains tend to have stable business records.
Furthermore, social factors in sustainability also include a company’s stance with regard to social trends, corporate responsibility and contemporary issues concerning the economy.
This brings us to corporate governance, one of the biggest attractions for investors. Nowadays corporates seem driven enough to improve governance practices to enhance relationships with stakeholders. Sound governance gives stakeholders confidence about an organisation’s business ethics. They have faith that the company would adhere to the core principles of accountability, transparency and responsibility. They expect the organisation to comply with regulations, not have lacunas in documenting the processes and never make misleading claims.
How does sustainable investing work?
Brings us to the key question: Is ‘sustainable’ truly sustainable?
A targeted approach is the key here. Fund managers screen each investment diligently while evaluating the company’s processes and outcomes. Nothing is left to chance. This formal process enables them to assess whether the company is on course to achieving its sustainability objectives.
Different ESG criteria are applied. Companies with high ESG ratings get first preference. There’s negative screening too that excludes so-called sin stocks like tobacco, coal, gambling, alcohol and firearms from the investment portfolio.
Similarly, cause-oriented companies are ranked higher. The element of volatility increases for companies that bank on materials from geopolitical regions and deal in products that divide public opinion.
Fund performance is monitored closely. A feedback loop is created for impact measurement. It enables fund managers to gauge whether the investment is in a position to meet the portfolio targets going forward. Called the Theory of Change model, it allows the impact investment industry to translate ESG intentions into real impact results.
Is sustainability profitable?
Finally, do investors find these funds financially rewarding enough? There’s a confidence that sustainable investing could drive the future economy.
Companies can generate growth while being sustainable. Moreover, financial institutions have been acknowledging that businesses factoring in ESG issues are in a stronger position to offer handsome returns. That you need to sacrifice good investment returns to practice sustainable investing is a myth.
Recent studies also indicate that performance of sustainable investment matches that of conventional investments. Sustainable firms engage more skilled and faithful employees and have loyal stakeholders too. This strong chain of relationships ensures that sustainable funds remain on a stable footing and become great stocks for the future.
Many businesses committed to sustainability leverage technology to make production even more resourceful. In doing so, they increase efficiency of vehicles and machinery in the supply chain. Also, sustainability combines different segments together, resulting in fresh, profitable ideas.
Such innovations invariably help to lower costs and generate higher yields.
The initial investments in sustainability might necessitate expensive materials, but all of these will lead to considerable savings down the road and deliver superior share performance. Investors will only benefit from the whole system’s efficiency in the long run.
Not to undermine the role of banks who are demonstrating growing interest in financing these projects.
Sustainable investing for institutional investors?
It’s not merely banks that are upbeat about sustainable investing. Institutional investors are becoming one of the biggest drivers of sustainably-oriented funds. Large institutional investors in India, including sovereign wealth funds and pension funds, are embracing the sustainability model.
In fact, institutional investors are showing the way with progressive ideas. They’re not just weeding out activities such as coal, tobacco, alcohol and arms manufacturing, but are screening positive sustainability outcomes. It isn’t a box-ticking exercise anymore.
Regulations driving greater ESG disclosures have further boosted the confidence of institutional investors.
Stock exchanges too have played a part in creating indices that include companies meeting the sustainability criteria.
To sum it up, enlightened investors want to engage with companies championing sustainability. But sustainable investing is not just about making the world a better place. It isn’t a trade-off either – sacrificing profits for values – or being plain ecologically responsible. Investors believe sustainable investment can be quantified with the same thoroughness as conventional investment. They perceive sustainability as profits with purpose.