Originally posted at Foundation & Endowment Intelligence.
Sustainable investing is ballooning. The engine of the sustainable investing machine is fired up and ready to go, but roadblocks are holding back movement. Asset managers have an opportunity to respond to the market demands and modernize the investment landscape. If they do so, they stand to reap the rewards.
Data from the U.S. Forum for Sustainable and Responsible Investment, a leading voice advocating sustainable, responsible and impact investing across all asset classes, which counts hundreds investment management and advisory firms, mutual fund companies, research firms, consultants, foundations and other asset owners as members, says that $1 out of every $5 of professionally managed assets is now invested with some consideration for environmental, social and governance (ESG) factors. This represents a 133% increase in four years, accelerating a trend that began more than 15 years ago.
While market growth is clear, the field is still young. Key infrastructure—the "glue," so to speak, holding the industry together—has yet to dry. Market holes prevent investors from fully embedding sustainability factors into practical decision-making.
But, as new research from the World Resources Institute lays out, there are three critical steps asset managers and other investment professionals can take to overcome these barriers:
1. Deliver actionable investment frameworks.
A negative screening strategy, like fossil fuel divestment, may sound relatively simple to implement, but for most investors it’s actually not. For those wanting a more holistic sustainable investing approach that captures a broader set of opportunities and risks—such as those relating to climate change, resource scarcity, worker treatment or poverty—it quickly becomes even more complex. This absence of concrete frameworks puts a huge onus on asset owners and managers, and can easily squelch early enthusiasm of asset owners.
Asset owners and their consultants can fix this by developing new investment frameworks and making existing ones more concrete, with practical guidance, for integrating sustainability across an entire portfolio. These frameworks would provide answers to underlying questions such as: What is a "sustainable" portfolio? How does one evaluate opportunities for sustainable investing? How does one ensure assets are poised to survive—and thrive—in the future world? Such frameworks should have a long-term perspective and be accompanied by clear guidance for managers, including a standardized questionnaire for evaluating investment opportunities. With these resources, investors can more systematically structure their portfolios in a way that effectively accounts for sustainability risks and opportunities.
Investors need to hear from asset owners demanding better reporting on sustainable investments. Photo by Sam Valadi/Flickr
2. Build up reporting standards and data.
In recent years, the market has seen a large influx of ESG data and disclosure standards, but missing elements—including an absence of standard performance metrics—limit their utility for mainstream investors. For example, an investor looking to evaluate opportunities in asset classes beyond public equities will struggle to find a consistent source of ESG data. Even in public equities, they will encounter a shortage of data for sector specific metrics, like carbon asset risk, commodities risk and various social impacts. Data for emerging country markets is even harder to come by. And even where data is available, it’s rarely in a format that is immediately compatible for integration.
Standardized global reporting requirements would strengthen the integrity and accuracy with which sustainable investors can do business. There are several efforts underway for such reporting standards, including from the Sustainable Accounting Standards Board and the Financial Stability Board’s Task Force on Climate Related Disclosures. But these and most others are voluntary.
It’s up to asset managers to pressure companies to disclose this information. WRI offers a number of tools to help companies do this, including Aqueduct for measuring water risk, Global Forest Watch for monitoring deforestation, and the Greenhouse Gas Protocol for measuring and reporting greenhouse gas emissions. But these resources and data sources alone are not enough.
A starting point is for investment practitioners to develop guidance on how to use existing data to construct a sustainable portfolio. This would help investors identify which ESG factors are material to their investments, how to best measure those factors in a given sector, and where to source that information.
A larger endeavor would be to provide a single platform for aggregated data, with emphasis on materiality. Having all the information in the same place would make robust analyses easier, eliminating many of the biases introduced by multiple data sources and inconsistent methodologies. Another valuable advancement would be to develop performance metrics on key material ESG issues, such as benchmarks tied to the UN Sustainable Development Goals.
3. Strengthen the investment chain.
While investment strategies that incorporate ESG are increasingly available to institutional investors, there are still not enough high-quality investment products to meet demand to fulfill a fully diversified, global, multi asset-class portfolio—the type most institutional asset owners demand. There are several reasons for this.
First, many of the existing products focus on very specific criteria, such as fossil fuel-free holdings or other negative screens. As investors have increasingly come to understand sustainability factors as material to companies, demand has grown, and investors want a broader, more proactive approach. They want products that incorporate these material ESG risks and opportunities—like water scarcity, workforce transitions, shifting consumption patterns and transformations in energy production. In other words, they want to manage all major risks and not miss out on significant future growth. Second, while there are public equity indexes, some fixed income products, and private equity options available to investors, there are not as many solutions-oriented listed equities or hedge funds. The private investments require deep due diligence because of their complex structures and long lockup times, and not all consultants are well prepared in this area. (Private equity isn’t even an option for some asset owners due to minimum investment requirements, illiquidity and other factors.)
To get asset owners beyond simply having a small sustainability carve-out, asset managers need to offer more quality sustainable investment strategies across the diversified portfolio of asset classes. Investment consultants also need to be more proactive in pursuing research and due diligence on newer products, and seriously considering offering, and even recommending, the products to clients.
Asset owners can also play a role here. They can come together and demand products that integrate material ESG factors, thereby demonstrating to asset managers a critical mass of capital. Asset owners can drive demand by asking their investment consultants and outsourced chief investment officers to prioritize sustainability and bring forward sustainable investment product options.