Our industry is engaged in an important dialogue to improve sustainability through ESG transparency and industry collaboration. This article is a contribution to this larger conversation and does not necessarily reflect GRESB’s position.
The urgent need to address the severe consequences of climate change has made it imperative to shift towards a more sustainable economy. However, this transformation requires significant investments, especially for facilitating a green and low-carbon transition. As a result, the private sectors, such as the real estate industry, have been urged to participate in finding sustainable solutions.
Sustainable finance is an approach to finance that involves taking into account not only financial returns but also the impact of investments on the environment, society, and governance issues. It is the process of integrating environmental, social, and governance (ESG) considerations into investment decisions and risk management practices. The aim of sustainable finance is to encourage more long-term investments in sustainable economic activities and projects, which will ultimately benefit the environment and society.
What is Sustainable Financing?
Sustainable finance recognizes that financial markets have a critical role to play in supporting sustainable development. By promoting transparency, accountability, and good governance, sustainable finance can help ensure that investments are made in a responsible and sustainable manner. It can also help identify risks and opportunities associated with environmental, social, and governance factors, which can lead to better-informed investment decisions.
One of the key drivers of sustainable finance is the increasing demand from investors to take socially responsible actions into account. Sustainable finance provides investors with a range of options to invest in sustainable economic activities and projects, from green bonds to impact investing.
The ‘E’: Environmental considerations include climate change mitigation and adaptation, biodiversity preservation, pollution prevention, and the circular economy.
The ‘S’: Social considerations refer to issues of inequality, inclusiveness, labor relations, investment in human capital and communities, and human rights issues.
The ‘G’: Governance of public and private institutions, including management structures, employee relations, and executive remuneration, plays a fundamental role in ensuring the inclusion of social and environmental considerations in the decision-making process.
The outcomes
The extent of the sustainable investing market varies considerably across different regions. European asset managers hold the highest proportion of sustainable investments (52.6% at the beginning of 2016), followed by Australia, New Zealand (50.6%), and Canada (37.8%). Sustainable investing is less widespread in the United States (21.6%), Japan (3.4%), and other Asian countries (0.8%), however, the gap is closing. Interestingly, from 2014 to 2016, the volume of sustainably managed assets outside of Europe grew significantly faster than within Europe.
Investors are increasingly demanding that their wealth and asset managers provide investment products that not only deliver strong performance but also align with their ESG values. According to a study by Morgan Stanley that evaluated over 10,000 funds and managed accounts,investments in sustainability have typically performed as well as, and often better than, comparable traditional investments. This outperformance is evident across asset classes and over time and is measured both on an absolute basis and a risk-adjusted basis. The study cites the example of the MSCI KLD 400, an index composed of companies that meet a rigorous ESG standard, which has achieved an annualized return of 10.2% since 1990. By comparison, the S&P 500 delivered an annualized return of 9.7% during the same period, a difference of 45 basis points.
What was once considered a niche practice has now become a substantial and fast-growing market necessity. According to the Global Sustainable Investment Alliance, sustainable investments accounted for 26 percent of assets under professional management in Asia, Australia, New Zealand, Canada, Europe, and the United States, amounting to a total of USD 22.89 trillion at the start of 2016. This figure marks an increase from 21.5% of assets four years prior.
The Millennial shift
The opportunity to maintain financial success and couple it with value-based investing has become an increasingly popular investment strategy, especially for millennials.Millennials have demonstrated a stronger inclination than previous generations to choose investments that align with their values. In fact, a recent Morgan Stanley survey found that 84% of millennials prioritize investing with a focus on ESG impact.
Wealth and asset managers must recognize the demographic changes occurring in the investment industry. In order to serve the over USD 4 trillion market, they must adapt quickly and consider sustainable investments to attract the coming wave of millennial investors.
Millennials are becoming more involved in their investments, seeking to have more control over their financial future. They are not just interested in making a profit but also in using their investments to create positive social and environmental impacts. They are nearly twice as likely as non-millennial investors to take this approach, according to a Morgan Stanley study. For millennials, values-based investing is the third most important priority out of the nine identified priorities.
In addition, they prefer to purchase products from sustainable brands and are more likely to exit investment positions due to objectionable firm activity. They are also more concerned about environmental, social, and governance (ESG) practices when making investment decisions, with 17% indicating they seek to invest in companies that use high-quality ESG practices compared to 9% of non-millennial investors.
A study by Inyova in Germany determined that 86% of millennials are interested in impact investing and are twice as likely to invest in funds related to ESG causes. Moreover, the newer generations, such as 72% of Gen Z’s, see sustainable funding as a long- term solution. Some investors wish to “do good” for society by providing capital to companies with favorable ESG features (without compromising risk-adjusted returns), making ESG a crucial pillar of sustainable investing.
The sustainable investing market has seen remarkable growth, with a compound annual growth rate of 107.4% and an increase in AUM from USD 1.0 trillion in 2012 to USD 4.3 trillion in 2014, according to The Forum for Sustainable and Responsible Investment’s 2014 report. Moreover, the number of sustainable investing funds available has almost tripled since 2008.
This impressive market growth is only driven by millennials but also by evolving macroeconomic trends. With an estimated 2 billion additional people expected to be added to the world population by 2050, the global demand for food, water, and energy will necessitate innovative improvements in infrastructure to address the resource demands associated with a growing population.
Is it worth it?
Recent comprehensive research that analyzed more than 2,000 studies conducted over the last four decades has demonstrated that sustainable investing does not lead to poor returns. This finding has been encouraging for many investors, who now have compelling reasons to pursue sustainable investment strategies, especially given the other benefits associated with sustainable investing.
For example, companies have seen their revenues and profits decline following incidents that would fall under the “social” functioning, such as worker safety mishaps, waste or pollution spills, or certain disruptions caused by extreme weather events. Such ESG incidents can significantly harm a company’s brand and therefore decrease its market value. As a result, investors are increasingly scrutinizing how companies manage ESG risks and are demanding greater transparency and disclosure from companies on these issues.
Players that do not effectively manage ESG risks face the prospect of losing market value and profits, damaging their brand, and being unprepared for long-term risks such as climate change and water scarcity. As such, it is becoming increasingly important for companies to prioritize ESG risk management and to provide investors with transparent and meaningful disclosure of their ESG practices.
Thanks to the growing availability of ESG performance data, investors are now able to apply more advanced screening techniques that filter out companies based on more refined and nuanced criteria. Investors can use negative screening to reduce risk by excluding companies, sectors, or geographies based on ESG performance.
On the positive side of ESG reporting, negative screening incentivizes companies to improve their ESG performance and adopt more sustainable practices, thereby driving positive change and creating a more sustainable future for all.This involves avoiding investments in companies or sectors exposed to material sustainability risks while maximizing returns without undue risk of loss.
Implementing this “must-have”
The value of sustainable investment has grown steadily by 15% in major financial markets over the past two years, showing no signs of stopping anytime soon. In addition to a global standard, data, and solutions are needed to move towards a net-zero future. The Global Sustainable Investment Alliance (GSIA) reports that sustainable investment in major financial markets globally was valued at USD35.3 trillion since the beginning of 2020, accounting for 36% of all professionally managed assets across several countries.
There are many ways to implement sustainable choices, such as:
promoting changes in regulatory frameworks
harmonizing public financial incentives
increasing green financing from various sectors
investing in clean and green technologies
financing sustainable natural resource-based green economies
and promoting the use of green bonds.
These factors are not only necessary for ESG scores but have also proven to increase asset value. Therefore, sustainable investment is a current “must-have” in the world of real estate investment and asset protection!
This article was written by Maya Fink, Content Manager at Deepki.
