Sustainable investing has grown fast in significance in recent years. But what exactly does it mean? The main aim of traditional investing is to generate the highest possible return from assets with a predefined risk. Sustainable strategies, on the other hand, go much further. For example, they support activities that provide social or environmental benefits, and rule out those that cause environmental or social damage.
Studies have shown that factoring social and ecological considerations into investment decisions at the very least does not produce inferior long term results. If the companies selected meet sustainability criteria, performance is likely to be better in the long run, as these firms often have better governance and face fewer legal risks. Sustainable investing can therefore be defined as any form of investment strategy that incorporates environmental, social and governance considerations in its investment decisions. The acronym ESG – for environmental, social and governance – is commonly used to refer to these three key factors.
Three concepts for green money
We can distinguish between three main investment approaches: exclusion, integration, and impact investing. The exclusionary principle defines activities that investors would prefer to avoid financing at all costs. For instance, they can stipulate that they do not wish to invest in the manufacture of weapons, or in the tobacco industry.
The integration concept goes much further. In this case, the extent to which companies satisfy sustainability criteria is looked at in detail during the analysis and selection process. For example, they are screened for social and environmental criteria (such as their CO2 footprint, not using child labor) and in terms of suitable governance. Because more and more institutional investors such as pension funds and insurers are adopting these investment principles, various sustainability ratings and certifications have been established for corporate reporting (financial and otherwise) that help with assessing companies.
Investing with impact
Impact investing is without doubt the strictest approach to sustainable investing. It explicitly measures an investment’s social or environmental impact and accords this “sustainability return” as much importance as the financial return in its overall evaluation. To date, investments of this kind have largely been driven by institutional investors.
The author, Daniel Kalt, is Chief Economist of UBS Switzerland.