In this issue, we are expanding from our water only focus to share a broader view on the growth in sustainable investing.
We feel sustainable investing is leading to change throughout the financial industry and is being mainly driven by demand from a new generation of wealthy investors who are looking beyond pure financial return. Hedge funds, private equity groups, family offices, and sovereigns are also entering into the scene.
We define sustainable investing as creating market based returns and more – the more being where metrics can highlight those improvements and those returns to the community, environment, jobs, nations.
We do NOT view sustainable returns as concessionary returns often linked with charitable giving or hybrid investment/philanthropic styled giving. We feel that sustainable investing will be integrated into an overall investment thesis. This will largely be driven by institutions, pension funds, sovereigns, corporates, and family offices in addition to high net worth individuals and ultimately at the retail level (i.e., the rest of us with our relatively smaller wallets than those larger players previously mentioned). We feel in the future, all smart investing will have sustainable components.
You may have heard an alphabet soup of abbreviations related to this topic including CSR, SRI, ESG, or even EI, II:
CSR: Corporate Social Responsibility
SRI: Socially Responsible Investing
ESG: Environmental, Social & Governance
EI: Ethical Investments
II: Impact Investing
We will talk more about the above in future blogs as there is an inherent messiness surrounding this topic, which has only served to confuse both the industry and the masses.
Today, we will focus on Sustainable Investment and investing. What happened, why now?
The “Great” Wealth Transfer — Trillions!
In 1998, two researchers named Schervish & Havens from the Social Welfare Research Institute at Boston College published a report estimating an impending wealth transfer period in the United States from the Greatest Generation / Baby Boomers to their heirs of $25 Trillion (from 1998-2052). While this figure has been touted in the media and refuted over time, there is a clear consensus that a great deal of the wealth generated during the post-World War Two boom period in the U.S. And, that this wealth would be transferred over the next few decades to a new generation of heirs. Particularly the generation labeled Millennials or Generation Y (generally identified as those born between 1980 and 2000). In 2014, Schervish & Havens updated their estimates to $36 Trillion being directly transferred to heirs from 2007-2061.
Catalyst for Change — Enter the young generations Y & Z!
The process of transferring wealth creates its own pressures on the financial industry. Particularly for wealth advisors, as there is a strong trend for new heirs to re-evaluate how these funds are going to be managed. In a Merrill Lynch study in 2013 titled Millennials & Money, 51% of high net worth investors said “no” or were “undecided” about if they would use the same financial advisor as their parents. A strong percentage of those surveyed (72%) also characterized themselves as ‘self-directed’ investors. And, they either did not use advisors or only used them for special circumstances. Clearly, financial institutions will need to create new approaches, products and services to meet the preferences of this new investor class during this transition period.
Looking Beyond Financial Return — Impact!
One of the clearest preferences of this new generation of investors appears to be their strong interest in using their investment strategies to ‘express’ their political, social and environmental values. For instance, in a wealth survey done by U.S. Trust in 2014, one-third (1/3) of total high net worth individuals reported using social impact strategies, while two-thirds (2/3) of millennials reported doing so. Also, while a Morgan Stanley report from February 2015 showed that 71% of investors were interested in sustainable investing, this figure rose to 84% for millennial investors.
These preferences are being translated into action as well – for instance, the US Forum for Sustainable and Responsible Investing reported that the amount of money being invested under sustainable and responsible investing (SRI) strategies almost doubled from 2012 to 2014 from $3.5 Trillion to $6.6 Trillion. While the growth of sustainable investing has been strong, there are still some perception issues that need to be addressed.
Perception issues with Sustainable Investing — is this just charity?
As mentioned previously, the clearest problem with this space is what to call it since there is a wide range of terminology and labels used in the industry including names we didn’t mention before like “green investing” and “values-based investing”.
For our purposes, we use the term sustainable investing to represent the integration of environmental, social and governance factors into the financial analysis and investment processes. This integration is NOT used as a filter (either positive or negative) for individual stock selections, but instead is used to expand the analytical factors evaluated that can impact return. This is important since another issue in this space is the incorrect belief that financial return must be traded in order to achieve impact return.
For example, in the Morgan Stanley survey report mentioned earlier (Sustainable Signals, Feb 2015), 54% of the investors interested in sustainable investing believed that there is a trade-off of financial return for adopting these strategies; even though 72% believed that good environmental, social and governance performance could lead to higher corporate profits. A lot of this confusion is due to the different terminology we discussed and the different investment strategies that are frequently being “lumped” together in this space.
Impact Investing for instance is one of the more widely used terms, but this strategy can include investors with a wide range of investment objectives. In a recent JP Morgan / Global Impact Investing Network (GIIN) survey on Impact Investing, 55% of impact investors identified their strategies as targeting “competitive, market-level returns”. That means that a little less than half were indeed willing to trade-off some financial returns for impact returns. This trade-off is not required and does not need to be applied to the broader world of sustainable investing strategies – in fact, 92% of the impact investors in the JP Morgan survey who were seeking competitive returns reported achieving outstanding or in-line financial returns on their investments.
Meeting the Needs of Sustainable Investors — Risk versus Reward!
While all of the major financial institutions are developing sustainable finance / investing teams and there have been a strong growth of private equity funds into this area, there is still a strong need for additional financial instruments in the sustainable investing space, particularly with different risk and return profiles.
The majority of focus so far has been in the private debt and equity markets, particularly towards asset classes like infrastructure and real estate (agriculture, water infrastructure). On the public market side, there are a range of sustainability-focused indices and Exchange Traded Funds or ETFs, but the majority of investor focus in this space is directed towards shareholder activism and resolutions.
The most visible sector in this space has been the Green Bond market. This market has been growing very fast ($11 Billion in 2013, $39 Billion in 2014 and projected to be $65 – $100 Billion in 2015) mainly driven by commitments by leading banks to invest in this sector. For instance, Citigroup announced in March 2015 that it was increasing its target for participating in the green bond market (lending, investing and facilitating transactions) to $100 Billion by 2025 after achieving its previous goal of $50 Billion announced in 2007 by the end of 2013. The World Bank is also another major player in this space, having issued over $8 Billion in green bonds by early 2015 through 80 transactions. This market will also likely receive a major boost by global commitments taken at COP21 since green bonds are frequently used to fund low-carbon initiatives.
Coming Back to Water — Blue Gold is becoming a hotter topic every year!
Tying this blog back to our common theme on water, there are many ways that sustainable investors can tailor their investment strategies with water-focused instruments.
This includes mutual funds (e.g., Calvert Global Water Fund (CFWAX), Indexes (e.g., First Trust ISE Water Index Fund (FIW), ETFs (e.g., Invesco’s PowerShares Water Resources Portfolio (PHO), and Hedge Funds (e.g., Water Partners Fund – Aqua Terra AM). Many larger, long-term investors like pension funds and sovereign wealth funds have been investing directly in large water-related companies; in 2012, British Telecom’s pension scheme and the China Investment Corporation both bought stakes in Thames Water in the UK.
The Expanding Influence of NGOs and Philanthropies — a louder voice!
We couldn’t leave the discussion on sustainable investing without mentioning the increasingly important role that Non-Government Organizations or NGOs, non-profits and philanthropies are having on the evolution of this space. Whether it is the UN’s Principle for Responsible Investing (PRI) Initiative to CERES.org, which created the Global Reporting Initiative (GRI) standard in 1997 for sustainability reporting guidelines, to the emerging Sustainability Accounting Standards Board (SASB), it is clear that these types of organizations are taking the lead over governments in driving corporations and the business community to integrate sustainability into their operations and reporting.
This step is critical since investors need reliable, comparable and consistent data in order to make sound investment decisions. The Fortune 500 has also woken up to the need to be active and aligned with these organizations, which can easily be seen by looking at their expanding lists of corporate partners. The result is large agricultural, water focused and conservation focused organizations are at the forefront of partnering and creating awareness with the consumer driven big iconic brands as demographic demand for beverages, food, automobiles, and land only continue to grow as the populations increases. Some forecasts are that we will reach 8.5 Billion people on the planet by 2030.
Final Thoughts — Time to Invest!
Overall, we see the sustainable investing space entering a significant transition period. Capital is moving from a exploring new sustainable investments “fringe focus” towards the mainstream with significant levels financial and investment analysis and due diligence. Was is particularly interesting is that millennial investors are already in process to inherit — the number often commented on is north of $45 Trillion Dollars these days.
While direct investments and large pools of institutional actively seeking investment, this will not happen overnight. The ‘snowball’ is rolling and will only pick up speed and size from here, until ultimately there will be no need for the moniker of ‘sustainable’ investing; it will just be business as usual.
Institutions are seeking larger investment sizes to put to work, i.e., $25 to 50 to $100 Million with ideally $Billions in the pipeline as they do not have the capacity to make micro-investments. Larger projects will attract capital a faster rate as the natural investment disciplines and metrics can be put to work immediately.
We feel we are only seeing the tip of the iceberg, and there is more to come.
Christopher Meissner was formerly a vice president with France Telecom building wireline and wireless products across multiple international markets, and currently is now at Columbia studying to complete his Masters in Sustainability Management.
Gregory Mark Hill was formerly in M&A and tech investment banking in New York and Silicon Valley, venture capital in China, and now manages assets and is in private equity to the sustainable sector and also serves as adviser to asset management platforms, impact start-ups and social entrepreneurial organizations.