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Sustainable finance: if the spread is not tasty

11 January, 2019Ouida Taaffe
ToastThe December 2018/January 2019 edition of our member journal, Financial World, features a series of articles looking at some of the issues around sustainable investing and its impact on both the planet and on financial services. Editor of Financial World, Ouida Taaffe, gives a summary of the issues covered.

Sustainable investing was, until quite recently, among the marmites of financial services: either you loved it or it was an irritation in an already busy agenda. Those who loved it could lay claim to a certain moral superiority: they were forgoing petty gains to save the planet. Those who ignored it also laid claim to a certain moral superiority: they were carrying out their fiduciary duty by maximising returns. Now sustainability as an investment approach has become a mainstay of the menu. According to the Global Sustainable Investment Association, in 2016 the investment analysis for around 30 per cent of investable assets globally – assets amounting to c. US$20tn – factored in sustainability. East & Partners estimate that over 60 per cent of investors and around 50 per cent of issuers around the world have a strategy to reflect environmental, social and governance issues (ESG) in their work.


Central banks are also paying attention. The Bank of England, in its Transition in thinking: The impact of climate change on the UK banking sector, September 2018, pointed to two paradoxes in dealing with the financial risks posed by climate change.

The first is that the costs of catastrophic climate change would be borne by future generations, so there is no real incentive for anyone to do much about it now, and once there is a “clear and present danger” to financial stability it could be too late to row back.

The second is that if the financial system moved too quickly towards a low-carbon economy that in itself could “destabilise markets, spark a pro-cyclical crystallisation of losses and lead to a persistent tightening of financial conditions: a climate Minsky moment”.

Relieving the tension

Could the capital markets help find the solution to that tension? Commentator Simon Thomas points to  research that suggests that carbon-efficient companies can command a large spread over carbon-inefficient assets – with some generating an “alpha” of up to 5.4 per cent a year. That should make green investing attractive, particularly as even much smaller excess returns are not easy to generate.

However, one of the reasons why the market average is hard to beat is that, at scale, there is a lot of competition between companies and between investors. The cohort of outperformers – whether investors or companies – is small, which would suggest that the universe of carbon-efficient assets is also not large. Ben Caldecott, a founding director of the Oxford Sustainable Finance Programme at the University of Oxford, believes this is the case.

Caldecott argues that the numbers quoted are often misleading because the definitions behind them are overly elastic. However, like Brenda Trenowden CBE, he expects the amount invested in sustainable assets to grow. Caldecott says this will be partly because of necessity and partly because rich countries can afford it. Trenowden points out that large sums will have to be put to work to meet the United Nations’ 17 sustainable development goals 2030, which offers major opportunities for investors.

Greenfield investment in projects that are earmarked to meet the sustainable development goals may make it relatively uncomplicated for investors to both make a return and make a difference. What, however, about existing assets, especially if sustainable investment is still a work in progress?

Getting active

Some investors have started to apply an activist approach, finds financial journalist Christopher Alkan. He says these investors are taking stakes in companies that can gain from being more sustainable and pushing them to make the change – often with good results for those investors who know what they are doing.

But how willing investors are to put their returns where their ethical concerns are? Investment journalist Andy Davis looks finds that millennials are the group most likely to feel that some things matter more than money; but also that pension funds will be required to closely examine their stance from 2019.

Social investment expert Peter Morris points out that people need clarity on how their funds are being used and exactly what sort of return they can expect. “Social investing”, he notes, is not about making a return at all, but about trying to do good. If that is not spelt out, he says, fund trustees will always choose a green label with some payback over one that has none – which leaves projects that cannot make money, but do make a difference, to wither.

Green reward

Finally, what about pragmatic investors who want both a return and the sense of doing good? It seems that, increasingly, there is evidence of a “green reward” and that low-carbon investments can outperform.

Extract from Financial World magazine, December-January.

Find out about Financial World

Ben-CaldecottIn our next series, Ben Caldecott explains how more detailed information on climate change is helping develop sustainable investment strategies and alter financial practice.

See our Centre for Sustainable Finance

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