Intro
Sustainable investing has become a booming investment category. According to the Morningstar 2020 Sustainable Landscape Report, there are now more than 300 sustainability-oriented mutual funds and Exchange Traded Funds (ETFs) in the United States with total assets as of 2020 just under $150 billion—up nearly 35% in the past three years.1 While stock markets tumbled as a result of the COVID-19 pandemic, sustainability funds showed much greater resilience than other investment vehicles. And as markets recovered, the flow of capital into sustainable equity funds outpaced competing conventional equity funds.2 As attention shifted from the public health crisis to economic recovery, a growing emphasis emerged in many circles on the need to “build back better”3—meaning more sustainably. In addition, the Black Lives Matter protests that erupted around the world in 2020 threw into high profile a series of social concerns including racial justice and economic inequality and raising questions about corporate cultures and workplace diversity. All of these recent events offer a signal of just how significant sustainable investing and finance have become—and explain why interest in environmental, social, and governance (ESG) metrics has taken off.
This interest spans the world. Indeed, the Global Sustainable Investment Alliance estimates that the assets under management (AUM) in funds that deploy some form of sustainability screening in their investment strategy now exceed $30 trillion.4 While this figure may be an overestimate—because the depth of the sustainability focus considered by these funds varies widely—the scale of these numbers suggests that sustainable investing must be seen not as a fad but rather the new essential lens for investors in the twenty-first century.
Tracking Trends
The growing interest in sustainable investing reflects a number of trends that this book seeks to map and explain. Most notably, an ever-expanding number of mainstream investors have begun to insist that their portfolios better reflect their values—including their concerns across a spectrum of environmental, social, and governance (ESG) issues. Of course, investors range widely in their specific interest in ESG performance, with some focused narrowly on single issues such as climate change or diversity in the workplace. Others want to exclude companies that produce goods or services that they find objectionable, so some funds engage in negative exclusions—divesting from whole industry categories such as alcohol, tobacco, gambling, and firearms, or from poor performers on select issues such as greenhouse gas emissions or respect for human rights. And yet others simply want their investments tilted toward companies that are moving the world toward a sustainable future and to underweight those that are not helping to shift society onto a sustainable trajectory.
The rising interest in sustainable investing and finance, and the related focus on ESG reporting, has begun to reshape not just equity markets but the world of fixed income investments as well. So-called green bonds, for example, grew from $2.6 billion in 2012 to $257.7 billion in 2019.5 As this volume demonstrates, a similar push toward sustainability can be found among private equity investors, hedge funds, and other specialized investment vehicles.
Investors vary not only in the sustainability issues they care about but also in how they deeply they want to lean into sustainability factors and their tolerance for risk, leading to a wide range of sustainable investing strategies. Some strategies seek to deliver outsized returns or green alpha. Others simply tilt toward sustainable companies using smart beta strategies. And some are aimed at investors who will accept sub-par returns because their focus is on impact investing, which means they prioritize societal benefits alongside their financial gains.
A second factor driving interest in the flow of capital toward support of a sustainable future can be traced to two landmark 2015 agreements: the UN Sustainable Development Goals (SDGs) and the Paris Climate Change Agreement. The 17 SDGs spell out a set of clear policy priorities for governments across the world, highlighting the need for improved results on a diverse set of critical challenges including hunger, poverty, clean water, economic development, human rights, and climate change.6 Beneath the 17 topline goals, the UN effort specifies 169 quantitative targets to sharpen the focus on what needs to be done by not just governments, but also the business community and non-governmental organizations of all kinds. In this regard, the negotiations that led to both the 2015 Paris Agreement and the SDGs made it clear that success in achieving progress would require substantial flows of capital toward meeting the needs that had been defined.7 Both agreements specifically indicate that traditional development assistance and other government funds will be insufficient to the task—and thus that private capital will be essential for expanded sustainability efforts in general and to the global response to climate change in particular.
Policymakers estimate that as much as $3 trillion per year in new investments will be needed to shift society toward a sustainable energy future and to meet the targets set by 2030 Sustainable Development Goals.8 Delivering capital at this scale necessitates a vast increase in sustainable finance—with funds flowing toward sustainable projects, infrastructure, and companies. The UN Secretary General has outlined various barriers to the scale-up of funding for sustainability projects9 with particular emphasis on “misaligned incentives and regulations, limited awareness, and difficulties in identifying, measuring, and reporting on sustainable investments.”10 Various chapters in Values at Work offer suggestions about how to overcome these obstacles.
Investment Logic
Both more data on corporate ESG performance and expanded incentives to channel capital toward companies and projects are needed to facilitate the transition to a sustainable future. But whether sustainable investing makes sense from a financial perspective continues to be debated. In the chapters that follow, we review the issues under contention. In particular, we explore the theoretical logic for inves...