The new wave of sustainability

What do we mean by "sustainable investing"?

Sustainable investing may have become all the rage over recent times, but what do we really mean by this?

And is it enough just to target assets that are inherently “green”?

As the world attempts to chart a path to net zero, so sustainability has reached the top of the agenda among investors. One expression of this is the Net-Zero Asset Owner Alliance, established in 2019 and already counting 73 institutional investors as members, which between them manage over $10 trillion in assets. Another is the 450 institutions responsible for over $130 trillion of capital committing, in the run-up to COP26 last year, to transitioning the global economy to net zero.

There is certainly regulatory pressure for companies, asset managers and institutional investors to take action on the climate front. The E of ESG received a significant boost, for example, as the European Union implemented the first phase of its Sustainable Finance Disclosure Regulation in March 2021 and released its environmental taxonomy through last year. In the US, the Securities and Exchange Commission is also proposing rule changes to require companies to make climate-related disclosures.

The push towards sustainable investing is significant. But there are also pull factors in the form of investment potential. In his capacity as UN Special Envoy for Climate Action, Mark Carney (also Vice Chair and Head of Transition Investing at Brookfield) said in a report that the “transition to net zero is creating the greatest commercial opportunity of our age”, with US$3.5 trillion of investment needed to transition just the energy sector over the next three decades.

Shifting capital

The focus so far has naturally been on investing in clean energy and related projects and technologies. Yet we are now witnessing a shift in attitudes as investors increasingly recognise that this alone will not be sufficient to drive the change necessary for the world to meet the Paris Agreement goals. Brookfield, for example, has recently raised a US$15 billion transition fund. “This will focus not just on clean and green power,” says Carney. “It will also invest in businesses that currently have high greenhouse gas emissions. They have big capital needs and are undervalued – in part because they are high emitters. The strategy is to help them reduce their emissions, align with net zero and create value along the way.”

He adds: “We won’t get to where we need to be if those at the sharp end cannot own a steel company. We need people who can go into these companies and drive the transition.”

It’s a view shared by other GPs. “Energy companies are part of the future,” says Edwin Conway, Senior Managing Director, Global Head, BlackRock Alternative Investors. “We have to invest in existing companies to help them transition by bringing private capital to bear. If we don’t take energy or mobility companies with us to net zero by 2050, we will miss our collective goals.”

A way forward

However, the issue with this shift is that many investors may have to see the carbon footprint of their portfolios increase over the short term. They may well fear that this could have reputational and, for those on the public markets, valuation repercussions, as Carney notes. “We can’t have a world where it is toxic to own something that has high emissions,” he says. “Investors should be encouraged to invest in these businesses with a plan to help them transition.”

The publication of the draft Net-Zero Transition Plan by the Glasgow Financial Alliance for Net Zero (GFANZ), however, may offer at least part of the solution. It provides a framework for financial institutions to demonstrate the credibility of plans to reduce emissions across all industries. “This will give investors information not just about a company’s emissions, but also what it intends to do about them,” says Carney.

“We’ve seen many LPs develop sophisticated objectives focused on reducing emissions, but they are now realising that these may need to increase if they are to capture some of the bigger value opportunities from transition. GFANZ makes the world a safe space for precisely that type of investment.”

There are signs that this view is filtering through private markets. While the number of impact funds (those investing in inherently impactful sectors with an objective of generating a positive social or environmental outcome) continues to increase, so does the number of non-impact funds that seek to generate some form of impact. “We are seeing a convergence of ESG and impact in private markets,” says Britta Lindhorst, Head of European Investments at HQ Capital. “They don’t have to be impact funds to be creating an impact in companies.” Those signing up to the new Science-Based Targets for private equity are among these. As is Mindful Capital Partners, according to Inna Gehrt, Head of the German Office. “We see ESG not as a risk reduction tool, but as an opportunity to change a company,” she says. “We invest in businesses that are not inherently green; rather we transform industrial companies.”

This kind of shift is not for the faint-hearted and may well lead to accusations in some quarters about greenwashing. Yet, as Carney stresses: “There needs to be investment in decarbonisation in every region, sector and company to reduce emissions and this creates opportunities across the economy. But you do have to deliver the emissions reductions.”

We can’t have a world where it is toxic to own something that has high emissions... investors should be encouraged to invest in these businesses with a plan to help them transition."