Sustainability the ‘way of the future’ for institutional investors

Focus on innovation an entryway into private equity before it becomes publicly listed, says head of Canada for Schroders

Sustainability the ‘way of the future’ for institutional investors

Sustainable and impact investing are still top of mind for Canadian institutional investors despite performance worries, says the ‘2023 Institutional Investor Study’ by global asset manager Schroders.

The annual study – which spans 770 investors across 36 regions and US$34.7 trillion in assets, includes 83 Canadian investors representing $5.2 trillion in assets – says that while performance is still a main concern for those looking to implement sustainable strategies, many recognize the need for further defined metrics and frameworks.

When asked why they would invest in sustainability and impact strategies. Canadian investors answered:

  • Because of an appetite for or investing in new sectors (e.g., nature-based solutions, green hydrogen, just transition, etc.) to achieve portfolio diversification and expand to new themes / asset classes (67 percent)
  • The belief that investing in sustainable investments is required to achieve long-term financial returns (e.g., this is simply good business) (64 percent)
  • Over half of Canadian investors cite performance concerns as a barrier to increasing their organization’s sustainable investments.
  • Seventy percent of Canadian investors believe that engaging with companies directly to ensure workers are protected and fairly rewarded is one of the most effective methods for investors to make a positive impact.
  • Sixty-two percent of Canadian investors believe that the energy transition will spur investment in innovation, and in turn, create significant investment opportunities.
  • Infrastructure (86 percent) and natural capital / biodiversity (84 percent) are cited as the two asset classes most suited to deliver sustainability and impact objectives over the next two years.
  • When asked for their preferred approach to investing sustainably, Canadian investors highlighted exclusion (61 percent) and thematic (60 percent) as their preferred approaches.
  • In achieving net zero goals, 50 percent of all Canadian investors believe that their organization needs both more consensus around frameworks as well as support in measuring and tracking the path.

Private asset investing provides diversified and sustainable investing options

Private asset investing is gaining momentum on the sustainable front in response to inflation as well as the technological revolution. Similar to the sentiment around sustainable investing, more broadly, many Canadian investors are still wary of private assets as there is a lack of historical knowledge around fund performance over time.

The report makes a case for private asset investing:

  • Seventy-one percent of Canadian investors see the opportunity to achieve higher returns than they could via public markets as one of the most important benefits for investing in private assets now versus in two years.
  • Fifty-seven percent of Canadian investors cite that the limited track record for both financial and sustainability performance of funds / mandates is one of the biggest obstacles for sustainably investing in private assets.
  • Nearly 35 percent of investors expect to increase their allocation of private assets over the next two years. In comparison, only four percent of investors note they would increase allocation to cash and nine percent note increasing emerging markets investments.

“We’ve seen a lot of interest in private markets in the Canadian market and Canadian investors have been investing for a very long time in private markets, infrastructure, and real estate,” says Michelle Skelly, head of Canada for Schroders. She adds that on a global scale, “Canada is pretty advanced when it comes to investments in private equity.

“If you're dating back 20 to 30 years, there was more incentive to go into real estate and infrastructure, but private equity has been increasing in part because of the return profile.”

Schroders postulates that there will be major shifts in the three areas of decarbonization, demographics, and deglobalization that will have long-term implications for the global economy. The firm calls it the ‘3D Reset,’ and says it will result in higher and more volatile inflation with consequences for central bank policy and resulting implications for growth.

Skelly says a lot of the resulting innovation comes on the private equity side, including advancements in artificial intelligence and a confidence in technology. “I think getting into innovation is an entryway into private equity before it becomes publicly listed.”

The same can apply to sustainability, with “people trying to not solely rely on traditional energy and instead looking more at energy transition such as wind, solar and other alternatives to generating energy. That’s the way of the future, especially with everyone focused on reducing their carbon emissions. Again, that fits into technological innovation, and it starts being born on the private market side before it goes public.”

The Schroder report also makes the case of a marriage between sustainable and private asset investing strategies:

  • Eighty-eight percent of Canadian investors state that private equity is the best suited to deliver sustainability and impact objectives over the next two years.
  • Over half of Canadian investors list the technological revolution as a key investment theme that they are seeking to proactively allocate to via private assets.

Canadian investors say their two top strategies for the best way to make a positive, measurable impact as a private assets investor include partnering with specialized asset managers to benefit from their sustainable investing expertise and collaborating to develop internal sustainability resources and know-how (27 percent). In addition, they actively engage with portfolio companies and borrowers to ensure achievement of impact targets (e.g., net zero targets as part of climate alignment) (26 percent).

Deglobalization, inflation, and geopolitical uncertainty impacting allocation strategies

Over the past few years, investors have become well acquainted with uncertainty due to the main forces of deglobalization, monetary policy / inflation, and geopolitical action affecting portfolio returns and investment strategies. Despite these concerns, Canadian investors still have confidence in achieving portfolio goals in 2024 and beyond.

As deglobalization accelerates, Canadian investors believe the impact on the global economy and asset allocation involves institutional investors looking towards investing in companies with more localized supply chains (56 percent) and seeking more exposure in private markets and alternatives to capture innovation in productivity-enabling technologies (54 percent).

As well, Canadian investors say the main influences on overall portfolio performance over the next year to be rising inflation (56 percent), tapering of monetary policy (51 percent,) and geopolitical uncertainty (47 percent). Ninety per cent of Canadian investors are at least somewhat confident in achieving their organizations’ return expectations over the next two years.