{"id":31885,"date":"2021-02-21T10:55:07","date_gmt":"2021-02-21T18:55:07","guid":{"rendered":"https:\/\/lapost.us\/?p=31885"},"modified":"2021-02-21T10:55:07","modified_gmt":"2021-02-21T18:55:07","slug":"understanding-the-rapidly-evolving-world-of-sustainable-finance","status":"publish","type":"post","link":"https:\/\/lapost.us\/?p=31885","title":{"rendered":"Understanding the Rapidly Evolving World of Sustainable Finance"},"content":{"rendered":"

Source:\u00a0https:\/\/insight.kellogg.northwestern.edu\/article\/sustainable-finance-investing-four-experts?utm_source=subscriber&utm_medium=email&utm_campaign=pianomailer022021&pnespid=1ep0rOZRAguNZER3ZIsC8PYotUYHcQASTGliP0jh<\/a><\/p>\n

It\u2019s no longer a niche investment strategy\u2014and it has the potential to deliver strong returns.<\/p>\n

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BASED ON INSIGHTS FROM<\/div>\n

Ravi Jagannathan<\/a><\/p>\n

David Chen<\/a><\/p>\n

Brian Bruce<\/p>\n

Lloyd Kurtz<\/p>\n<\/div>\n<\/div>\n<\/section>\n

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Sustainable finance has officially gone mainstream.<\/h3>\n
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As of 2019,\u00a0$30.7 trillion<\/a>\u00a0is held in sustainable or green funds, representing a third of all assets under management. And the share is growing quickly, with many funds reporting\u00a0record flows<\/a>\u00a0into sustainable investment products during the first half of 2020.<\/p>\n

\u201cThe big story in last five years is that the mainstream asset management industry has committed to getting involved in sustainable investing,\u201d says\u00a0Lloyd Kurtz<\/a>, a visiting scholar at Kellogg who also leads the Social Impact Investing Team at Wells Fargo Private Bank.<\/p>\n

Moreover, contrary to popular opinion, most investors pursue this strategy not as philanthropy, but as a logical business decision, says\u00a0Dave Chen<\/a>, CEO of Equilibrium Capital and adjunct professor of finance at Kellogg. \u201c[It\u2019s not:] \u2018Hey, since you guys are out saving the world, you don\u2019t have to generate the returns.\u2019\u201d<\/p>\n

Still, confusion abounds. What does sustainable investment look like? How has it changed over the years? And what kinds of returns\u2014social and financial\u2014can investors actually expect to see?<\/p>\n

We asked for the perspective of several experts, each of whom had recently served as a judge for the\u00a0Moskowitz Prize<\/a>, the premier global prize for research into sustainable finance, which was awarded by Kellogg for the first time in 2020.<\/p>\n

Here\u2019s what they had to say about the state of this rapidly evolving field.<\/p>\n<\/div>\n

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3 Primary Techniques<\/h2>\n

One of the reasons why sustainable investing can seem confusing is that it can take three fundamentally different forms.<\/p>\n

The first, exclusionary screening, involves avoiding investments that go against the beliefs of the investor, explains\u00a0Brian Bruce<\/a>, CEO and Chief Investment Officer at Hillcrest Asset Management, and editor in chief of the\u00a0Journal of Impact & ESG Investing<\/em>. For example, investors (or their managers) might exclude oil, gas, and coal companies or tobacco companies when building their investment portfolio.<\/p>\n

\u201cWhile exclusionary screening has historically been associated with faith-based investment, it is the traditional method for implementing ESG strategies back to the days when the field was called \u2018socially responsible investing,\u2019\u201d Bruce says.<\/p>\n

ESG integration is a more recent approach that involves considering a range of environmental, social, and governance (ESG) criteria in\u00a0every<\/em>\u00a0investment decision.<\/p>\n

\u201cIt goes beyond exclusions and requires assessments of ESG performance for every opportunity in the investable universe,\u201d says Bruce. \u201cA manager will score and assess the entire opportunity set.\u201d<\/p>\n

In ESG integration, managers consider criteria like how green a company or industry is, or how well it treats its employees, and then prioritize companies that score better on these assessments for inclusion in their portfolios. However, managers are generally still looking for strong financial performance from their investments.<\/p>\n

The third technique, impact investing, starts with the slightly different aim of \u201cpromoting positive change in the world,\u201d as Bruce describes it. While profits are welcome, they may take a back seat to other goals.<\/p>\n

\u201cTypical themes include clean energy, clean water, and support for education. Investors seek to achieve these goals through direct dialogue with companies (active ownership) or through specialty venture, microfinance, and\/or private equity vehicles,\u201d Bruce says.<\/p>\n

In the chart below, Bruce provides examples of how these three different approaches might tackle various environmental, social, or governance goals.<\/p>\n<\/div>\n

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\"examples<\/div>\n<\/div>\n
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Doing Well by Doing Good?<\/h2>\n

One of the biggest questions surrounding sustainable finance is whether taking into account these ESG criteria actually\u00a0benefits<\/em>\u00a0investors financially.<\/p>\n

On the surface, this seems an unlikely prospect. After all, any time you place limits on the investment opportunities in your portfolio, you reduce its efficiency. Such limits\u2014either via exclusionary screening or poor ESG performance\u2014ought to come with financial costs, at least theoretically.<\/p>\n

But Kurtz points out that historically this has not been the case. In fact, he says, \u201cfor many years, we\u2019ve observed that companies with better sustainability records tend to have better earning power in terms of return on equity or return on invested capital. That\u2019s been true almost since the start of sustainable finance decades ago.\u201d<\/p>\n

There are plenty of possible reasons for this.\u00a0Ravi Jagannathan<\/a>, a professor of finance at Kellogg, sees risk management as playing a large role in making sustainable investing profitable. In his view, professional institutional investors and money managers are obligated to maximize returns\u00a0and minimize risks<\/em>\u00a0for their clients. That means looking ahead to how those risks might shift in the future.<\/p>\n

\u201cLaws are not static,\u201d Jagannathan says. \u201cFor example, many consumers feel an ethical obligation to shift their consumption toward green products with a lower emissions footprint.\u201d Moreover, as the public becomes increasingly aware of the costs imposed by greenhouse gas emissions, additional legislation becomes more likely. Legislators might implement carbon taxes, for instance.<\/p>\n

\u201cFirms with responsible business practices are better at perceiving such shifts in consumer behavior, anticipating potential changes in laws, and developing new technologies and supply chains that reduce harmful emissions,\u201d Jagannathan says. \u201cThey are also more likely to attract and retain talented workers and have more satisfied customers\u2014resulting in better and longer-lasting cash flows. Such firms are therefore less risky.\u201d<\/p>\n

In this respect, an investment manager\u2019s decision to prioritize investing in companies that score highly on ESG criteria could simply be considered a smart part of the risk-management process. Indeed, there is some evidence this is already how some\u00a0investment managers are thinking<\/a>.<\/p>\n

Similarly, large institutional investors could pressure the companies they currently invest in to make changes that would reduce risk. In fact, evidence from this year\u2019s\u00a0Moskowitz Prize\u2013winning paper<\/a>\u00a0suggests that the efforts of activist investors can be quite effective. The research finds that firms targeted by activist investors went on to make capital improvements to their plants that significantly reduced the release of toxins and greenhouse gas emissions.<\/p>\n

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Not a \u201cGimme\u201d<\/h2>\n

Chen also takes the view that investing in companies with sustainable business practices is a good financial move, particularly in industries like energy, where it\u2019s becoming clear that a changing climate will change demand moving forward.<\/p>\n

For many investors and investment managers, he says, the decision process is quite simple. \u201cWe\u2019ve recently hit an inflection where investors have to ask themselves: \u2018Do I want to invest in yesterday, or am I investing in the growth industries of tomorrow?\u2019\u201d<\/p>\n

Tesla is being handsomely rewarded by the market, after all, because it believes that the low-carbon, electric economy will ultimately become the transportation economy of the next few decades.<\/p>\n

\u201cThe investors that are skyrocketing this asset are not doing it because they believe that sustainable investing is a \u2018gimme\u2019\u201d or act of charity, Chen says. Indeed, when GM announced its pledge to sell only zero-emissions models by 2035, its\u00a0stock jumped 3.5 percent<\/a>\u00a0by the end of the day.<\/p>\n<\/div>\n

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\u201cWe\u2019ve recently hit an inflection where investors have to ask themselves: \u2018Do I want to invest in yesterday, or am I investing in the growth industries of tomorrow?\u2019\u201d<\/p>\n

\u2014 Dave Chen<\/p>\n<\/blockquote>\n<\/div>\n

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Ditto for investments into, say, high-production greenhouses. Chen\u2019s firm manages funds that invest in greenhouses that create a controlled environment, managing the carbon dioxide, temperature, light, and humidity levels to optimize vegetable productivity, safety, and quality.<\/p>\n

\u201cSeventy percent of what we eat comes out of California, because California has perfect weather,\u201d he says. \u201cBut the weather in California is changing: climate issues, drought issues, fire issues.\u201d<\/p>\n

\u201cEffectively, every day is the same in this greenhouse and every day is tuned to the spectrum of light and the climate characteristics that a specific plant thrives in,\u201d Chen says. \u201cThis becomes a climate adaptation tool and a tech-enabled productivity tool. Am I investing because this a \u2018gimme\u2019 or because this is the future? Investing in the next generation of the economy is just a smart investment.\u201d<\/p>\n

ESG Grows Up<\/h2>\n

Whatever the reason, investors have taken note. Demand for sustainable investing, particularly from institutions, has never been larger.<\/p>\n

\u201cIt is no longer a niche product. It is considered an essential part of the asset-management industry. And the reason for that is that customers are demanding it,\u201d says Kurtz.<\/p>\n

But he notes that as interest in the field has blossomed, so has scrutiny.<\/p>\n

\u201cOver the past decade, there\u2019s been a significant increase in the staffing of ratings agencies, and in the professionalization and implementation of the ratings systems,\u201d Kurtz says. \u201cSo when we say a company is a \u2018good sustainability performer\u2019 or \u2018bad sustainability performer,\u2019 there\u2019s a lot more detail and nuance that\u2019s going into that judgment.\u201d<\/p>\n

Different ratings agencies will prioritize different criteria\u2014and likely come to different conclusions about how a given company fares. This complexity, he explains, will make it increasingly difficult to draw a simple, tight relationship between sustainability and financial returns. Instead, he predicts that we will start to learn that some sustainability efforts produce more financial gains than others, and that effectiveness could differ by industry.<\/p>\n

Having more granular information will be critical for helping both investors and companies make socially and financially smart decisions. For instance, says Kurtz, \u201ctwo very strong studies by Alex Edmans at London Business School documented\u00a0a relationship<\/a>\u00a0between the way companies treat their people and the financial results they got.\u201d<\/p>\n

And research from Kellogg\u2019s own\u00a0Aaron Yoon<\/a>\u00a0supports the importance of employee satisfaction, finding that having satisfied employees is a\u00a0necessary condition<\/a>\u00a0for seeing a financial boost from other kinds of ESG investments.<\/p>\n

It is also important to understand that investors who take the third approach toward sustainable investing\u2014impact investing\u2014may see lower financial returns. \u201cAs you move away from public markets and toward products designed with a philanthropic component\u2014such as community foundations or microfinance lending\u2014you\u2019re entering an intermediate space between an investment and a grant. And so there it\u2019s perfectly appropriate to expect that the returns won\u2019t be market returns,\u201d says Kurtz.<\/p>\n

Still, impact investors interested in getting the biggest bang for their buck will want to stay tuned: future research should also illuminate the\u00a0efficiency<\/em>\u00a0of various tools for achieving social goals.<\/p>\n<\/div>\n<\/div>\n<\/div>\n<\/section>\n","protected":false},"excerpt":{"rendered":"

Source:\u00a0https:\/\/insight.kellogg.northwestern.edu\/article\/sustainable-finance-investing-four-experts?utm_source=subscriber&utm_medium=email&utm_campaign=pianomailer022021&pnespid=1ep0rOZRAguNZER3ZIsC8PYotUYHcQASTGliP0jh It\u2019s no longer a niche...<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[9],"tags":[],"class_list":["post-31885","post","type-post","status-publish","format-standard","hentry","category-opinion"],"_links":{"self":[{"href":"https:\/\/lapost.us\/index.php?rest_route=\/wp\/v2\/posts\/31885","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/lapost.us\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/lapost.us\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/lapost.us\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/lapost.us\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=31885"}],"version-history":[{"count":1,"href":"https:\/\/lapost.us\/index.php?rest_route=\/wp\/v2\/posts\/31885\/revisions"}],"predecessor-version":[{"id":31886,"href":"https:\/\/lapost.us\/index.php?rest_route=\/wp\/v2\/posts\/31885\/revisions\/31886"}],"wp:attachment":[{"href":"https:\/\/lapost.us\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=31885"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/lapost.us\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=31885"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/lapost.us\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=31885"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}