Last week, I spoke at the ARES Seminar on Sustainability in Real Estate in Tokyo about trends in Responsible Investing, and why green is the color of money. Without a doubt this is a hot topic, as Responsible Investing is getting more and more attention, while an increasing amount of investors are incorporating its principles into their investment process. But what exactly is Responsible Investing? According to the UN Principles for Responsible Investment (PRI), it is an investment approach that explicitly acknowledges the relevance to the investor of environmental, social and governance (ESG) factors, and the long-term health and stability of the market as a whole. The approach recognizes that the generation of long-term sustainable returns, depends on stable, well-functioning (and well governed) social, environmental and economic systems.
It is interesting to look at what has caused the awareness of this correlation. First of all, we (and the buildings we work and live in) consume natural resources faster than they can be replenished. While doing so, the emissions that are responsible for climate change just keep increasing. And besides these issues, there are other, unprecedented environmental and social issues. Just think about food, water and energy security, air pollution, waste streams, urbanization, human rights, supply chain labor standards, etc. Now these are clearly major concerns, but why should institutional investors care about them? Simply put: because it is core to their (fiduciary) duty. Which is to act in the best interest of their clients and beneficiaries. Responsible Investing requires investors to take a wider view, acknowledging the full spectrum of the risks that are facing the society as a whole. By incorporating ESG performance outcomes into their investment process, institutional investors can allocate capital in a manner that is aligned with the interests of their clients.
But that’s not the only reason why investors care. As Madonna famously stated back in the eighties: “We are living in a material world.” The aforementioned issues are not just environmental or social concerns. They are material, economic issues, and that makes them relevant to investment risk and return. Investors’ main concern is that sustainability-related risks, as well as the policies that are put in place by governments around the world to avert those risks, will damage the companies and portfolios they invest in. Shareholder value is at stake.
However, it’s not just about avoiding risks, because institutional investors also have commitments regarding financial returns. And so the question arises: can you invest responsibly AND achieve strong financial returns? The short but clear answer to that question is: yes. A number of studies have shown that responsible investment funds have outperformed relevant national benchmark indices, as well as average mainstream fund returns, over various time intervals. And even though the findings do not prove that these funds provided higher returns because of the fact that they are sustainable, it does illustrate that sustainability is compatible with good returns.
So, investors are increasingly turning to activism as a way to try and effect change on a number of sustainability issues. However, their success depends on their approach. To illustrate: the divestment community is growing rapidly. Divestment is the opposite of investment – it simply means getting rid of stocks, bonds, or investment funds that are unethical or morally ambiguous. Numorous stakeholders, such as colleges and universities, cities, counties, charities and religious institutions, already have committed to divest. And in the US, recent fossil fuel divestment protests have hit colleges nationwide. Nevertheless, there has been quite a bit of discussion around this approach. Some experts say that all that divestment comes down to, is changing the ownership of shares, not the total amount of capital invested in non-sustainable companies. As such, selling shares is not always seen as an effective tool for addressing the ESG challenges. Importantly, by remaining active owners and shareholders, investors have a greater chance of driving change, than they do by stepping away from the table. They can use their shareholder power to positively influence corporate behavior, instead of just kicking out their investment managers. Or as renowned psychologist Frederick Herzberger stated: “A kick in the ass produces movement, not motivation.”
What are examples of strategies that do have a positive impact on market transformation? Increasingly, investors are using a combination of approaches, such as direct corporate engagement, positive screening (or best-in-class screening), ESG integration, and sustainability-themed investing (which also includes investing in green bonds). These different strategies share one powerful principle, namely that in the end, institutional investors hold the key to market transformation, because they have the money. And actually, they have lots of it. To illustrate: the signatories to the UN PRI already represent over US$45 trillion of capital. By using that firepower to allocate their capital to companies working the hardest to improve their ESG performance, investors create bottom-up commitment.
Clearly, this also accounts for the real estate sector, as buildings not only contribute to sustainability-related risks, but are also adversely impacted by those risks. In order to transform the built environment into an energy-efficient, low-carbon and climate-resilient one, bottom-up commitment is needed. However, in order to allocate their capital responsibly, investors need to know which property companies and fund managers are doing well. Further, those that want to do well, need to know where they stand (in absolute terms and relative to their peers), and how to improve their sustainability performance. Because Lord Kelvin already stated over a century ago: “If you can’t measure it, you cannot improve it”.
This is exactly why GRESB was founded: to make sustainability performance in the real estate sector quantifiable. Currently, almost 50 institutional investors use the benchmark results for positive screening, and for engagement with their investment managers. And last year, over 630 property companies and funds around the globe used the benchmark results to improve their sustainability performance. More importantly, it’s very promising to see that since the start of the benchmark back in 2009, participants indeed have been able to show improvement. But obviously, we’re not there yet.
To conclude, today more than ever, green is the color of money. Investors that are willing to invest responsibly, are key to driving change in ESG approaches in the real estate sector (and beyond). That change will be crucial, because in the end, more than just shareholder value is at stake. Or, as the Chinese say so elegantly: “If we do not change our direction, we are likely to end up where we are headed.”