Wangari Maathai, 2004 Nobel Peace Prize winner, described how the scarcity of natural resources would give rise to conflicts and advocated for taking care of our planet. “In just a few decades, the relationship between the environment, resources and conflicts will be as obvious as the connection we see today between human rights, democracy and peace.”
The COVID-19 pandemic has caused household-savings rates to skyrocket across all economies as a consequence of the severe reductions in spending due to lockdowns and uncertainty. But today, checking accounts, bank deposits, treasury bills and bonds are barely or not at all remunerated. This low-interest-rate environment, which has persisted over a prolonged period, is forcing households looking for investment alternatives with higher returns to withdraw a high proportion of savings held in these financial products.
One of these alternatives is investing based on ESG (environmental, social and governance) criteria, which offers a wide range of products. If we break down the acronym, we can better understand how this type of investment is made:
Environmental investing focuses on financing projects of companies and institutions that aim to develop solutions to environmental problems. They often promote initiatives such as the efficient use of water, waste management, energy efficiency, disinvestment in fossil fuels and conservation of natural resources, as well as any alternatives that promote the energy transition and circular economy.
Social investing considers how the company manages its links with the community, including workers. It is oriented to projects that aim to improve society and promote the SDGs (Sustainable Development Goals) and social principles such as inclusion, equality, diversity, representativeness and solidarity, human rights, fair treatment of workers and philanthropic initiatives. Social investing is guided by a more ethical mindset.
Governance refers to corporate governance and considers the quality of the management of the companies promoting the projects to receive investments. Common criteria include the transparency of a company’s relationship with shareholders, employees, customers, suppliers and different levels of government administrations, as well as the quality of its own internal management in areas such as the structure of the board of directors or remuneration of directors.
Being involved in financing major socio-economic changes is one incentive for sustainable investment.
ESG investing is all the rage these days, and it is here to stay. Although figures vary, as there are still no official statistics on this type of investment, all sources indicate a significant growth of ESG investing in recent years, with a global volume of assets under management (AUM) estimated to have reached around one trillion US dollars. The Global Impact Investing Network (GIIN) estimated that at the end of 2019, the volume of impact, or ESG, investment under management reached a somewhat lower but nevertheless impressive figure, 715 billion dollars worldwide, representing a 37.5-percent growth over the previous year1. Other sources with more recent data have placed this figure even higher. UBS2 estimated it reached one trillion dollars in 2020, while Broadridge3 placed the figure at 1.3 trillion dollars. Morningstar, in its report “European Sustainable Funds Landscape: 2020 in Review”4, estimated that sustainable investment in Europe alone amounted to 1.133 trillion euros that year, making up 11 percent of the total assets managed by European funds.
Several factors may explain the increase in investments based on ESG criteria: the growing awareness, concern and interest of investors in social responsibility and the environment, accentuated in the last year in the wake of the pandemic that has ravaged the world. This is even more evident with younger generations. According to Morningstar’s report, the flow of new capital to sustainable European funds amounted to €233 billion in 2020, doubling 2019’s figure5.
Another factor is the continued growth of ESG funds, with an ever-increasing supply of sustainable investment vehicles. In its report, Morningstar’s data indicated that in 2020, 505 new sustainable funds were created in Europe, and 250 additional funds were repositioned in this direction, bringing the total number of sustainable funds in Europe to 3,196. Approximately 60 percent of the assets under management of these funds were allocated to equities and 20 percent to fixed income.
Greater transparency from companies—through rigorous and disaggregated reporting of environmental and social impact data from different business areas—may reveal their abilities to generate sustainable cash flows based on ESG criteria. More green and social bonds are being issued by companies and governments, facilitating the creation of investment vehicles based on sustainable fixed-income assets. The issuance of green and social bonds exceeded €15 billion in Spain alone in 2020, with a growth of 54 percent compared to 20196.
Another contributor is the increased regulation of governments, led by the European Union (EU), which recently approved relevant standards for sustainable investments—EU Regulation 2019/2088 on disclosures of sustainability information in the financial-services sector, or the SFDR (Sustainable Finance Disclosure Regulation), and EU Regulation 2020/852 on the establishment of a framework to facilitate sustainable investment, or the Taxonomy Regulation—with two objectives. The first is to provide a common framework that allows companies to determine if business activity is environmentally sustainable, with the goal of shifting capital flows toward those activities that promote ecological transformation and the circular economy. The second objective is for these regulations to allow citizens to compare investment options directly based on their sustainability. Financial-services providers must report to investors not only the sustainability risks that pose threats to their clients’ investments but also the potential negative impacts that those investments could have on the environment or social causes such as employment and human rights.
Also bringing about change are global political initiatives, such as the European Union’s Next Generation EU (NGEU) economic-recovery fund and President Joseph Biden’s administration’s sustainable approach to economic development in the United States.
Two-fold goal for savings: obtain profitability and contribute to sustainable social development
The idea that profitability and sustainability can go hand in hand is perfectly valid. In fact, Morningstar’s study “European Sustainable Funds Landscape: 2020 in Review“7 has shown that over the last decade, European ESG funds outperformed other funds and, on average, had lower fees. This excess return is explained by the fact that ESG funds are often made up of smaller companies, with a high proportion coming from the booming tech sector and a low proportion from the energy sector.
ESG investing helps reduce risk.
When we incorporate non-financial criteria into our investment decisions, we promote companies that are more responsible while also reducing potential investment risks. For example, a company that does not adequately address safety or environmental measures will have a greater risk of incurring occupational or environmental accidents (waste, pollution and so on), negatively affecting its value and shares.
In short, this type of investing allows anyone to contribute to initiatives that promote sustainable development. Individuals can choose investment vehicles or funds that follow non-financial ESG criteria while still obtaining financial returns and limiting their investment risks.
The expectation of enormous growth in ESG investment in the coming years is based on several factors: (i) growing demand for investment opportunities, especially from Millennials, that meet specific social or environmental goals, (ii) improved methodologies that confirm that sustainable-investment criteria are being followed and (iii) new legislation that requires greater transparency and promotes the creation of ESG investment products. This will expand the range of possibilities for individual investors who want to follow a combination of financial and non-financial ESG criteria. Therefore, by rewarding companies and institutions that meet ESG requirements, investors can contribute to sustainable development and positive social impact as well as make money.
1 Global Impact Investing Network (GIIN): “Annual Impact Investor Survey 2020, Page 40″.
2 UBS: Wealth Management – Global, Chief Investment Office, Market Insights, House View, Daily, 2020.
3 Broadridge: Global Market Intelligence, “Providing essential market intelligence on ESG investing,” September 2020.
4 Morningstar: “European Sustainable Funds Landscape: 2020 in Review,” February 3, 2021.
5 Ibid., Page 5, Report Note 5.
6 Spanish Observatory of Sustainable Financing (OFISO): “Informe Anual OFISO La Financiación Sostenible en España en 2020,” Page 7.
7 Morningstar: “European Sustainable Funds Landscape: 2020 in Review,” February 3, 2021, Pages 26-28.