Questions of sustainability

If you look at the websites of most major financial institutions, you will find a reference to socially responsible investing, ethical investing, impact investing, environmental social and governance (ESG) investing or similar phrases. Some asset management companies employ corporate ambassadors whose job it is to emphasise the company’s focus on sustainability.

Defining the concept

But, if sustainability is the central concept which runs through all the other phrases, what is it?

The first modern definition of sustainability came from the United Nations World Commission on Environment and Development (the Brundtland Commission) in 1987.

Its report, “Our Common Future”, tackling the uncontrolled use of natural resources (mainly deforestation) is most notable for coining the term “sustainable development”.

This was defined as a development process that aims “to meet the needs of the present without compromising the ability of future generations to meet their own needs”.

Right at the moment, mankind is not living in a sustainable way. We have two billion overweight people, and 700 million who are malnourished. All the while, we waste a third of all the food we produce. Many people have a car each, most of which are left parked 95% of the time, showing that we don’t really need as many as we have.

Quantifying the portfolios and flows

The good news is that a lot of people have already become fully aware of the problem.

A third of assets under management (AUM) of US investors are now under sustainable mandates – that’s $17 trillion out of $51 trillion in AUM that is managed professionally. Most of this money is invested by institutions, such as university endowments, pension plans or state government Sovereign Wealth Funds (SWFs). According to Morningstar Direct, sustainably invested fund assets increased by 39% through the first nine months of 2021 to $330 billion.

Sustainable investment is also large – and growing rapidly – in Europe, where ESG investment funds are more important than they are in the United States. In a report published about one year ago, the European Fund and Asset Management Association (EFAMA) noted that:

The number of ESG funds grew at more than double the rate of non-ESG funds during the past five years, with a significant acceleration since 2017. Equity and bond ESG fund assets increased by 197% and 181%, respectively, in this period. This growth reflects both the creation of new funds and the integration of ESG criteria into the investment process of existing funds.

Meanwhile, EFAMA found that ESG funds had increased AUM by 37.1% in 2020 to reach €1.2 trillion. Net sales of ESG funds had risen from €19.5 billion in 2016 to €235 billion in 2020.

Demographics mean that this trend will continue.

MSCI, a company which compiles stock market indices and other tools for investors, states that 95% of millennials (people born in 1981-96) believe in investing sustainably – i.e. in companies that fit the description above.

And millennials, who are more engaged on this subject than any other generation, are set to inherit $30 trillion from their baby boomer parents over the next 15-20 years. There will likely be a tsunami of capital that flows into sustainable assets.

Putting the theory into practice

So much for the theory of sustainable investing (and some hard numbers about the quantity of money that is involved).

What about the practicalities of sustainable investing?

One approach is to look for investment funds or exchange-traded funds (ETFs) which invest – or claim to invest – in a sustainable way.

One challenge with this approach is that there are just so many funds to choose from. In the middle of last year, for instance, Morningstar pointed out that 111 funds had been launched in the UK in the first three months of 2021 alone: these funds attracted flows of about £103 billion.

And not all ESG funds or ETFs are the same. A recent study of 49 ESG ETFs in the UK market found that:

The most common [structure] is the exposure to the broad market, via which a sustainable fund invests in hundreds or thousands of stocks providing investors with significant diversification of portfolio risk. Another possibility [for portfolio structure] concerns the investment in specific niches or sectors of the market. This policy, usually, entails that a significantly lower amount of stocks is held and, consequently, the diversification benefits weaken.

If you take this approach, remember that you have to understand how sustainable – or ESG friendly –each of the underlying companies in the portfolio are. Remember, too, that the companies in the portfolio are typically chosen – and weighted – on the basis of their stock market value. There is rarely any consideration of whether they look like attractive investments on the basis of the metrics that analysts tend to use.

A completely different approach is to try and identify individual companies whose activities are clearly promoting sustainability. Ideally these will also be companies who are leaders in their respective fields and/or clearly well placed to benefit from huge growth in sales. As discussed in a recent edition of Exponential Investor, demand for new technology typically really takes off once it has captured around 5% of the market that it is competing in. Demand for the technology is boosted as a result of the cost of the technology having plummeted – sometimes by over 90%.

At Southbank Investment Research, we have long been looking for companies with these characteristics for Exponential Energy Fortunes, Frontier Tech Investor and Revolutionary Trend Investor. Expect to hear more from us in the near future about individual companies that promote sustainability and that appear attractive as investments.

In the meantime, we will be hosting the Clean Tech Fortunes Summit next week.

It’s a free series of long-form video interviews, with some of the biggest names in technology which address climate change (climate tech) and sustainable investing more generally.

For instance, I will be speaking with Alice Ross. She literally wrote the book, Investing to Save the Planet, which is a brilliant read for anyone looking to improve the sustainability – and profitability – of their investments. Among much else, we will be discussing common traps that investors should avoid.

Another contributor is Amy Domini, who is a leader in the world of sustainable investing.

She co-founded the KLD 400 index, one of the first ever ethical stock indices.

And in the decades since, her firm Domini Impact Investments has driven the revolution in investing. We look at why investors should be optimistic about sustainable investment – and much else.

With interviews of four other outstanding commentators, we should explain all that you need to know about climate tech and sustainable investing – in just a few hours.

As noted above, the summit is free.

So, if you want to invest more sustainably, and more profitably at the same time…

Sign up here!

Until next time,

Kit Winder
Co-editor, Exponential Investor