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Sustainable Investing: Understanding Its Rapid Rise and Opportunities

Jacqueline Coombe is a freelance writer specialising in business development, marketing, and career development content.

Sustainable investment is any investment strategy that targets sustainability and financial objectives. In the past decade, there has been a burgeoning interest in sustainable investing and enormous growth in the amount of investment capital flowing into sustainable investment options. Annual flows more than doubled from 2019 to 2020 and have increased tenfold since 2018 and 25-fold since 1995. These options include initiatives and projects addressing climate change, environmental issues, ethical concerns, and other social or collective outcomes. Around one-third of all assets under management in the US are related to sustainable investing or ESG practices. So what explains the rise of sustainable investing and how is this trend likely to evolve in the future?

The rise of sustainable investing

Sustainable investing might have once been seen as a niche option, but today, it’s a growing segment with increasing investor interest. Growing numbers of managed funds utilize environmental, social, and governance (ESG) criteria to guide their investment decisions.

Europe’s largest asset manager Amundi has integrated ESG into all of its investments, and Blackrock, the world’s largest asset manager, will increase its sustainable assets from $90 billion in 2019 to $1 trillion by 2029. With the COVID-19 pandemic and longer-term challenges like climate change and the looming resource crunch, the need to address ESG-related risks and opportunities has become even more urgent.

Driving factors

Strong financial performance, public policy, and growing investor demand are the key driving factors behind the rise of sustainable investing.

1. Strong performance

One of the biggest factors behind the rise of sustainable investing is that sustainable investment options can offer better financial performance. While investors in this area might not be solely concerned with returns, the fact that investments in ESG have outperformed non-ESG alternatives has led to an even greater interest in sustainable investment options. According to Morningstar, 73% of its ESG indexes outperform their non-ESG equivalents. ESG companies across industries like materials, energy, and food and beverage are associated with lower volatility and solid returns when it comes to stock performance.

This is not surprising since more sustainable investment options or companies tend to refer to ESG principles to manage their climate-related, regulatory, legal, and other risks. As such, businesses that follow ESG practices tend to be associated with lower risk and may also be more appealing to customers.

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2. Public policy

Intergovernmental organizations and governments around the have highlighted and started mandating certain ESG requirements. For example, in the UK, legislation set to come into force in April 2022 will require listed companies to inform investors of all climate risks. These measures are aimed at facilitating a shift to a low-carbon economy.

The UN’s 17 sustainable goals are another example of the public policy trend towards encouraging or regulating sustainability in businesses. The goals aim to encourage countries to participate in a global partnership for sustainable development. These goals include affordable and clean energy, sustainable cities and communities, responsible consumption and production, and climate action. Together, they can function as a clear point of reference for investors and companies alike.

Countries around the world are legislating for carbon-neutral targets and goals. These include New Zealand, the US, the UK, Denmark, Sweden, and France. These regulations will serve to further accelerate the demand for sustainable investment and the shift of businesses towards sustainability practices, which then leads to more sustainable investment options for investors.

3. Accelerating demand from investors

Finally, increasing investor demand for these options has fueled the rise of sustainable investing. Research from Morgan Stanley’s 2019 Sustainable Signals survey revealed that around 85% of investors are interested in sustainable investing, a leap from 71% in 2015.

More investors, both retail and institutional, are aware investing in a company is about more than reviewing its financial performance. They’re willing to take time to understand the company’s ESG practices and divest from or exclude certain sectors from their portfolio based on ethical concerns. Just like consumers who want to spend ethically, these investors are conscious of how their investment decisions could help with the transition to a low-carbon economy, strengthen climate action, and other social causes. This might have motivated retail investors to seek out novel channels for investing. Crowdfunding platforms, for example, give investors the opportunity to invest directly in impactful ventures focused on social and environmental outcomes. At the same time, sustainable businesses might find it easier to raise funds through these channels.

The maturing of Millennials and Generation Z, who, by and large, tend to be more concerned with social impact and sustainability issues, has also contributed to this accelerating demand. The younger generations, faced with the prospect of a warming world with rising inequality and growing resource constraints, maybe even more concerned about ensuring their investments have a positive impact on social and environmental outcomes.

The future of sustainable investing

The sustainable investment industry is expected to increase by 433% from 2018 to 2036. Ultimately, the growth of sustainable investing reflects the increasingly widespread idea that investors should be just as concerned about the social impact of their efforts as they might be about financial performance. The considerable interest and activity in sustainable investing are most likely set to continue growing in the coming years.

With environmental pressures, rising demand from both retail and institutional investors, and government initiatives driving sustainability practices, companies will be even more motivated in incorporating ESG and related principles into their strategy. In addition, ESG practices tend to mitigate risks and lead to stronger financial performance, which has been an additional reason motivating companies to focus on their social and environmental impact. For investors, sustainable investing is a smart investment strategy that could see the achieving superior financial returns over the long run.

This content reflects the personal opinions of the author. It is accurate and true to the best of the author’s knowledge and should not be substituted for impartial fact or advice in legal, political, or personal matters.

© 2022 jacquicoombe

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