Sustainable investing strategy hard to justify 'if it's not adding alpha'

North American commitment to SI more nuanced, says industry insider

Sustainable investing strategy hard to justify 'if it's not adding alpha'
Todd Glickson

Sustainable investing (SI) continues to gain widespread acceptance among institutional investors and full integration is projected to surge in the next five years, says a study by Coalition Greenwich commissioned by AGF Investments.

In fact, nine out of 10 institutional investors in North America and Europe expect to be investing sustainably or working toward the goal of introducing SI practices into their portfolios within the next five years, says the ‘Coalition Greenwich Emerging Trends in Sustainable Investing Best Practices and Wildcards for Institutions Study.’ Indeed, implementing SI across portfolios with full integration is projected to grow to three times today’s level in five years.

The study explores the priority themes most often targeted by asset owners through thematic approaches showing that asset owners are focusing on energy transition, water services and climate adaptation. In fact, the energy transition at 34 percent is the area most targeted by assets owners through thematic funds. At the same time, participants from endowments and foundations cite a commitment to diversity, equity, and inclusion as the top reason to increase their sustainable strategies.

Integrating sustainability across asset classes

In addition, institutional investors are looking to integrate sustainability across asset classes. However, the motivation behind adopting sustainable investing practices differs with North American investors focused on improving risk-adjusted returns, and European investors focused on creating positive impact.

The trend toward full integration is picking up steam, says the report. Looking ahead five years, 63 percent of European institutions predict that sustainability will be integrated across their entire portfolio, and in North America, 55 percent of institutions expect sustainability to be fully integrated within five years. 

While European investors are committed to the environment as part of their investment strategies, in North American it’s more nuanced, says Todd Glickson, head of investment management – North America at Coalition Greenwich. “It’s not that there isn’t a commitment,” he says, “but there are some divergences in uptake in North America. [North American investors] are good with SI, but it also has to improve their risk-return profile. So, if it's not adding alpha compared to what I'm investing in presently, I may struggle to justify that to my constituent group.”

Glickson adds that one theme that investors are interested is transition investing. These include organizations that are transitioning from a certain market state to a greener state.

“There are industries that are considered ‘less clean’ such as oil or natural gas versus wind or solar,” he says. “There are companies in those spaces that have traditionally been in one space but are moving to a cleaner space. For investors who want to improve their risk-return profile and they want a diversified portfolio, they will have to look at firms that are at all different points on the spectrum.”

Gaining widespread acceptance

As sustainable investing gains widespread acceptance, it is moving into a new and more mature stage. Now that institutional investors have at least some experience with sustainable investing, certain common trends and best practices are beginning to emerge, says the report. These trends include:

  • Heightened expectations for investment performance: While some of the earliest adopters of sustainable investing were prepared to make a trade-off between impact and returns, investors today expect sustainable investments to match or outperform investment benchmarks—while also delivering positive impact.
  • A journey toward full integration: Although investors today are using a variety of approaches, the long-term trend appears to be a clear movement toward full integration of sustainable investment practices into investment processes across portfolios, asset classes and strategies.
  • Guarding against greenwashing: Greenwashing is acknowledged as a real concern, and investors are taking proactive steps to guard against it.
  • Enhancing potential for impact and returns with thematic strategies: Even as investors move to fully integrate sustainability into their portfolios, they continue to employ thematic strategies that allow them to concentrate assets in order to enhance environmental and social impact, as well as investment returns.

Even as the industry begins to coalesce around these and other emerging standards and practices, there remain some wildcards in the form of key unanswered questions and variables that will affect the future evolution of sustainable investing:

  • No consensus on impact measurement: As yet the investment industry has not reached any universal agreement on how best to measure the non-financial performance and impact of sustainable investments.
  • Regulatory headwinds and uncertainty: Political pushback in the United States against ESG investing and lingering regulatory uncertainty around the world remain headwinds to the continued growth of sustainable investing.

The journey to SI used to be about avoiding ‘sin stocks,’ but now asset owners are making SI an important part of their investment strategies. “People now are more thoughtful about what SI means and how to be part of it,” says Glickson.