Over the years, businesses have been attempting to answer the fundamental question – in whose interest should they act - the shareholders, all the stakeholders, the wider society, or the planet as a whole? The idea of the core purpose of a business has evolved from maximising shareholder returns, to balancing shareholder returns with the demands of a multiplicity of stakeholders, to serving the needs of the society it belongs to and protecting the environment.
Traditionally, businesses thought about the environment or society as something external which they can affect, however, there has been a growing recognition of the dependency of business on environment or social changes.
Moreover, there is a growing concern around potential flaws in the current socio-economic system that accentuates economic prosperity and incentivises business models that can cause significant damage to the planet and society in pursuit of profits.
This has led to the growth of purpose-driven companies and sustainable investments. Sustainable investing, therefore, is an evolution of traditional investing as it takes into consideration the environmental and social impact of an investment in addition to its ability to generate lasting financial returns.
A variety of investment approaches have emerged, ranging from impact investing, which aims to create social goods, to ethical investing, which propagates exclusive investment in things that support the planet and society.
Environmental Social Governance (ESG) and Socially Responsible Investing (SRI) became buzz words within the global investor community. ESG, as the name suggests, evaluates an investment proposal on three key factors – environmental impact, social impact, and governance factors alongside the conventional valuation methodologies to generate sustainable returns.
However, SRI goes a step beyond the ESG to prioritise or disregard a financial proposition based on broad ethical guidelines. It demonstrates investors' commitment to their purpose and how they are contributing to social and environmental causes.
Globally, investors are incorporating ESG considerations into investment analysis and decision making. Both equity and credit investment managers are assessing ESG risks and mitigation factors of their investments.
The number of investors who have signed up for the UN Principles for Responsible Investments (UN PRI) has reached over 3000 in the last 20 years, and these signatory investors have roughly $100 trillion assets under management, i.e. half of all assets managed in the world by private investors.
The huge focus on addressing the climate challenge by governments, regulators, and businesses has boosted the demand for sustainable investments globally. While governments are committing to net zero targets to decarbonise countries and global regulators are enforcing mandatory targets upon various industries, purpose-led businesses are committing to voluntary net zero targets to reduce carbon emissions from their own operations, and SRIs are decarbonising their investment portfolios by attempting to remove carbon exposure and increase allocation to climate solution portfolios.
Various governments have enacted regulations and started imposing a carbon tax using carbon credit to penalise large industrial emitters; this gave rise to the compliance carbon market. However, as businesses and investors are committing to voluntary reduction targets, carbon credits are being transacted in the voluntary carbon market which is showing a huge growth potential – the market size is estimated to increase 15-fold by 2030 and 100-fold by 2050.
It's a myth that a sustainable investment portfolio does not yield compelling financial returns. There is enough evidence to suggest that investors can build portfolios with significantly better climate characteristics but with the same, or better, risk adjusted returns. Climate solution portfolios have performed broadly in line with the rest of the market for the last 10-15 years, however, in the last 5 years they have outperformed the market.
This is primarily because the market has started to price in the scale of transition and the positive stories we see as the world moves from fossil fuels to renewable energy sources. Socially responsible organisations are investing heavily in infrastructure and technology to support sustainable business goals that will invariably reduce the costs of operations.
Banks are reducing financing to high carbon intensive businesses, offering discounted pricing on green financial products like mortgages, and helping businesses to raise sustainable funding. Institutional investors are rebalancing their portfolios and increasing exposure to climate solution-oriented businesses.
These changing preferences have accelerated the transition to a low-carbon economy by creating increased demand for sustainable products and simultaneously reducing the cost of operations and capital for carbon solution-oriented businesses. The transition scale is such that even if you are a passive investor and take an exposure to a standard market index, you will get carbon intensity reduction over time as the world is on a trajectory to reduce carbon emission.
As we celebrate another year of Indian independence, it is imperative for us to recognise our responsibility towards balanced growth, climate change, and social reforms. While the government is framing policies and allocating budget to support the social and environmental cause, there needs to be a collective societal push to demand businesses to embed sustainable development goals and have a purpose beyond profit.
As Mahatma Gandhi said, “The world has enough for everyone's need, but not enough for everyone's greed.”, now is an opportune time to tweak our investment philosophies to consider social and environmental factors besides financial returns!
(Saurabh Gupta is the India CFO, Head of Global Finance Hub, and Chair of the India Climate Working Committee at NatWest Group.)
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