The seven strategies of sustainable investment

Money, as the KitKat Klub taught us, makes the world go around. But I don’t think I’m alone when I say that for many years, I was wary of money.

Fear of money seems to be a common stumbling block for people attracted to careers in sustainability. We live modestly – often a result of a childhood with limited means – and can be guilty of confusing capitalism with consumerism.

Whilst studying for my MBA – notice how I casually dropped that little brag in there. Yes, I did go business school – I took a couple of money-related elective courses: one on behavioural finance (fascinating topic!) and the other on Investing for Impact.

With finance not being my background, I wanted to stretch my little grey cells and learn more about what is, let’s face it, the most important aspect of a sustainable business.

These classes helped me understand how to use capital as a force for good.

There’s philanthropy, obviously, but there’s also investors around the world who go beyond the basic contributions needed to tick a the ESG box on their asset listing, and who actively seek out businesses and projects that provide rigorous and measurable social or environmental impact… alongside some very healthy financial returns, of course.

Who doesn’t want the cherry AND the cake?

In a conversation last week, I shared some of these insights with a client and it quickly became apparent that, even though they were working with their finance team to prepare ESG reports and pitch for funding, no-one had ever taught them what sustainable finance means.

So, I thought it might be helpful if I share a quick overview of what I know.

Like so many phrases in the rapidly evolving sustainability landscape right now, “sustainable investment” does not have a fixed definition.

Instead, it’s a blanket term applied to investment that operates under a range of different strategies. These broadly fit into seven main approaches.

Exclusion

An exclusion strategy is essentially screening based on ethical considerations.

I expect all my readers make exclusion decisions for their personal finances – whether it’s buying locally produced food instead of imported alternatives, or avoiding certain brands or activities because of their approach to human rights, taxation policy or environmental protection.

For me, it’s AirBnB that gives me constant cause to pause. Sometimes it is the only viable option, but the impact of second home and holiday home ownership on both coastal communities and city centres is a real problem in my country. Locals are unable to buy homes in the town they love, and temporary residents contribute very little to the local economy.

I’ll always avoid AirBnB, if a hotel or locally run BnB is available, and affordable.

Engagement

Engagement is more proactive. As you’d expect.  

An investor executing on an engagement strategy seeks to make a positive impact by buying shares in a company, with the express intention of changing its policies or practices.

The first time I became aware of someone doing this would have been when TV chef Hugh Fearnley-Whittingstall bought a single share in TESCO plc, attended their AGM as a shareholder and mounted a campaign to improve the living standards for TESCO chickens. He was unsuccessful, but its often since struck me as a potentially powerful approach, if you’re able to build momentum.  

Years back, when I was learning sustainable procurement we were taught that it’s always better from an impact perspective to engage than to avoid.

The message “I’ll do business with you, if you change this” is more effective than a flat “I’ll go elsewhere”. Cheap suppliers will always find another buyer who isn’t bothered by ethical qualms.

ESG compliant investment

Now we’re starting to get a bit more technical. ESG funds integrate environmental, social and governance factors into investment decision making. There’s rules on how these funds operate in many jurisdictions, especially the EU.

In plain English, the investor will only put money into a company if it meets a certain performance threshold in one or more of these categories (usually minimum standards across the board, with more higher requirements on the E or the S depending on whether the portfolio is classed as an environmental fund, or a social fund).

All those reports that companies now write, and ESG rating systems they’re signing up to? They are used to show investors how the company scores in each of these areas. Lower ratings mean the company has more exposure to risk in a certain area – such as risk of disruption, because of flooding or other effects of climate change.

The company might not be doing anything wrong, but if they can’t evidence what they are doing, they won’t get the marks.  

The compliance requirements have developed because historically there was a lot of greenwashing. But this is now regulated and expected to grow, with Bloomberg estimated that $40 trillion of assets under management (money invested) will be classed as ESG by 2030.

Norms-based screening

Funds that screen on a “norms” basis exclude companies that don’t practice minimum standards of business in one or more of the E, S and G criteria, according to globally accepted norms.

For example, these funds would refuse to accept a company that doesn’t adhere to minimum age restrictions or other standards set out under the International Labour Organisation (ILO) Convention on Workers’ Rights.  

Another check might be whether companies that operate across jurisdictions align with the OECD’s Guidelines on Multi-National Enterprises? These are non-binding, so may be higher than legal governance requirements in any given country but they are the globally accepted “norm” for good business.

Companies wanting to pass a norms-based screening analysis, especially in countries where ESG regulation is still emerging, might consider signing up to the UN Global Compact.

Norms best in class

Similar to the above, but instead of looking simply to adhere to global norms, a best-in-class fund only invests in companies that are performing particularly well on a relevant ESG issue. They are, in effect, the best in their class – whether that’s specific to their industry or in general.  

Sustainability themed investments,

In a sustainability themed investment, investors align a fund with a particular theme. For example, a fund that only invests in renewable energy, or a Venture Capitalist who is only after medtech or related health products.

These funds tend to be highly specialised and work with sector experts who understand the trends, and/or are used where there’s a government drive (and funding) to address a specific sustainable development objective.

After all, you won’t want to go big on investment in sustainable forestry if the next election ushers in a party with a raft of “chop it all down” policies.

Impact investment.

The big one. Impact investments are made with the intention of generating a positive, and importantly, a measurable, social or environmental impact alongside any financial returns.

Measurement is key here, as this heightens transparency and increases accountability.

Generating positive change is the key differentiator between an ESG fund and an Impact fund – ESG invests in things that do no harm; impact pushes us to do better, and demands evidence of how that is achieved.

Impact investors still need and expect to see a positive financial return so the risk/return trade off must still stack up for a project to be investable, however money may not be the primary motivator. If the project fails to produce the expected social and environmental returns, investors typically have the right to withdraw their cash, or as a minimum, are protected against any commitment to further investment.

For this reason, impact investors often do deals with government investment vehicles; social bonds and green bonds are great examples of where the public sector has enabled impact investing.

Government can take more risk for lower returns as their chief concern (should be) social stability and the wellbeing of citizens. So, by underwriting at least some of the financial risk, they attract up front capital from investors willing to take a long-term view.

Anyone who’s been involved with community energy schemes might be familiar with the concept.

Let’s wrap this up

The order in which I’ve listed the different strands of sustainable investment here correlates to the order of assets under management, going from most to least.

Lots of funds operate exclusion principles. Strategies that avoid investment in sectors such as the arms trade, for example. My Local Government Pension Fund is under pressure to divest from fossil fuel, but has not yet made that commitment.

Impact investing has relatively little money committed, as it sets out much higher expectations. But this is changing, and .

With PWC estimating the value of investment portfolios globally will hit US$147 trillion by 2027, whilst the pace of social change continues to accelerate, driven by AI, geopolitical instability and concerns about the environment, it’s important that we spend this money wisely.

Philanthropic trusts and foundations, impact funds, and increasingly family offices, ask their investors to seek out projects where their money will make a progressive contribution.

Earlier in the year, I was at an event with the excellent Cliff Prior, CEO of the Global Steering Group for Impact Investment and he summed it up nicely with a comment that I’ve probably misquoted here, but which makes the point:

“You have investors who just want their money back, with a healthy chunk of interest, and you have those who want to use their money and influence to leave a favourable legacy.”

As we decide where to put our business, and personal, investments, let’s look ahead to the future markets and remember: if we want to build sustainable businesses, we need to place them on a sustainable planet.

Wishing you lots of love and a whole lot more profit,

G

If you’re starting to get to grips with sustainable investment, the following resources might be helpful: