For many years, the debate has raged among investors and academics about whether sustainable investors need to sacrifice returns in order to achieve their values. I would argue that we are not asking the right question. Instead, we should be asking what type of sustainable investment approach is most likely to deliver the returns that individual investors need?
When we talk about returns, this does not mean the same thing for all investors. Understanding an investor’s needs and motivation, such as short-term liquidity or long-term financial commitments, has always been central to the role of investment advisers.
On top of that, we now have a greater understanding that financial returns are not the only goal of all investors – societal or environmental returns, personal satisfaction, familial unity or legacy concerns are also central to many investors’ measures of success. We see this in incoming European regulation that will require financial firms to take into account ESG factors and preferences such as good governance or environment to support a client suitability assessment and not only investor preferences like risk tolerance, risk capacity and financial expertise.
We see this same trend today across many areas of society, not only in investment. For example, increasingly consumers understand that if a product seems too cheap to be true, it’s usually because someone elsewhere in the supply chain is bearing the cost.
Despite this broadening definition of returns, a growing number of investors think it is not necessary to accept impaired financial returns from sustainable investments. A PWC survey in 2021 found that over 80% of investors were unwilling to accept returns expectations for sustainable investments that were more than one percentage point lower that non-sustainable strategies.
A Natixis survey in the same year also found that only 20% of investors think they have to sacrifice returns to invest sustainably, compared with 64% in 2017. This suggests that asset managers will be held to account by their clients if their sustainable strategies do not perform as expected.
Even so, some investors are still willing to accept below market rate returns in order to finance sustainable activities, perhaps as an alternative to more traditional philanthropy. While this isn’t a position we expect all investors to adopt, it does illustrate the wide spectrum of expectations of returns that exist today.
Then there is the question of why academic studies cannot definitively prove that sustainable investments do not sacrifice returns. However, asking this question assumes that ‘sustainable investment’ is a standalone strategy that can be identified and studied. This is not true.
The market for sustainable investments today is hugely varied. Some strategies focus on well-run companies (the quality factor), or those with products that deliver solutions to environmental or social problems. Some try to blend the two approaches. Others prefer to use non-financially material ESG information to align their investments with their values (the so-called ‘do no harm’ approach). In addition, the range of environmental, social and governance issues that can impact industries and companies is vast.
When we consider the sheer variety of approaches, it becomes clear that defining a universe of sustainable investments to study is perhaps even more difficult than studying more traditional financial questions, such as whether active management generates alpha, or whether quantitative investing is more successful than fundamental investing.
Isolating the impact of the sustainable approach from influential variables such as market environment and investor skill is extremely difficult. This is why there is a place in the investment industry for investment consultants!
In any portfolio construction approach, the key levers for achieving desired returns are asset allocation and investment selection. This is no different for sustainable investments. Different asset classes provide different risk-return expectations as well as different ways of delivering direct or indirect impact, or the ability to access or avoid certain types of activities.
Today there are sustainable options for virtually every type of approach – passive, active, thematic, private and public equity, high yield and investment grade credits, and so on. But when selecting investments, the same level of attention to manager or security selection needs to be applied whether the investment is considered sustainable or not.
Does the approach make sense? How credible are the claims made by managers? All investment managers operate under a set of constraints whether that is related to liquidity, time horizons or sustainability concerns. The real question is whether the managers are skilled enough to build a portfolio within those constraints that will achieve their goals – and that’s the same question regardless of whether it is a sustainable approach or not.
What really matters in the end is – what are your goals, and how can sustainable investing help? That’s the only real question that needs answering.
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