Sustainable investing is now mainstream, but it is not going to where it would have the greatest impact. This is both a problem and an opportunity.
Money is a powerful tool. Put to good use, it can help solve many of the world’s ills, from climate change to human rights abuses. This is the goal of sustainable investing, one of the most effective methods of positive change.
A common definition of sustainable investing is financing which takes environmental, social, and corporate governance (ESG) into account when making investment decisions. A responsible investment might avoid weapons manufacturers, for example, while instead focusing on a builder of solar panels or a company with inclusive management. This is a broad definition – maybe too broad.
“I would suggest that sustainable investing is financing which directly contributes to achieving the UN’s Sustainable Development Goals (SDGs),” says Mathias Lund Larsen, PhD Fellow at Copenhagen Business School and the University of the Chinese Academy of Sciences.
Sustainable investing is becoming more important, both for those seeking investments and those looking to invest. Brian Deese is the former Global Head of Sustainable Investing at BlackRock, the world’s largest asset manager. He points out that the concept is now mainstream.
“Sustainable investing was once viewed as a trade-off between value and ‘values’. Yet today it is something investors can no longer afford to ignore,” Deese writes in the company's sustainability report. “There is a growing awareness that certain factors – often characterised as ESG – can be tied to a company’s long-term growth potential.”
The Global Sustainable Investment Alliance uses a generous definition of ‘sustainable investments’. They say about USD 35.3 trillion, or a third of all assets in five developed economies should be considered as invested sustainably. This sounds great, but it helps illustrate a pressing problem: sustainable investments don’t necessarily go to where they will do the greatest good.
“Money needs to go to where the marginal benefit is highest,” Larsen explains. “It’s great to invest in a European company that has a diverse board of directors, but wouldn’t an investment in the global South help the people in developing countries more?”
The UN has said we need an additional USD 2.5 trillion in financing every year to attain our SDGs. This is a lot of money, but a big problem isn’t just finding more financing, but putting it where it will do good.
“Capital goes to where the risk-adjusted expected return is highest,” says Larsen. “Investors are willing to take a risk on a start-up in the North, but not in the less developed South.”
The Global Sustainable Investment Alliance suggests that most of the sustainable financing are in Europe and North America, and not where it would have a higher impact. People tend to invest in what they know, and they know local companies. Many asset managers are also constrained by internal regulations about where and how they invest, but the avoidance of less developed countries seems extreme.
“Investing in Brazil, Russia, India or China would not lead to much higher risk profiles,” says Larsen. “In the case of China, it has a huge capital market which falls within the risk appetite of Northern investors. The marginal benefit of investing here is among the highest in the world, but the risk profile is not that high.”
Larsen says the most efficient way of meeting SDGs is to invest where the marginal benefit is greatest, such as in less developed areas. Here the investor has the valuable opportunity to make money and contribute to SDGs simultaneously. Sustainable investments in overlooked areas make more sense from a social, human development and environmental perspective.
Even though people would like to do a little good with their money, investors still tend to focus on profit. But even this is good news. Blackrock points out that sustainable investments have benefits to an investor’s bottom line as well.
“Our research, which relies on back-tested data, shows how ESG-focused indices have matched or exceeded returns of their standard counterparts, with comparable volatility,” Deese writes.
There remain some important reforms to make to encourage sustainable investments to go to the right places. Larsen suggests pension funds need liberalised regulations, so they aren’t stuck geographically. We need more transparency in investing. The South also needs better marketing, so investors understand the real risks and opportunities in the region. If we make the environment right, money will flow to where it should: where it benefits people in need.
“In the future, I hope we see sustainable finance increasingly prioritised,” Larsen says. “I’d like to see factors such as biodiversity included in ESG criteria. Most of all I hope to see money going to where the SDG benefits are the largest.”
Wärtsilä’s approach to sustainability has made it a part of several sustainable development indices: https://www.wartsila.com/sustainability/our-approach/sustainability-indices
Wärtsilä’s commitment to carbon neutrality: https://www.wartsila.com/media/news/26-10-2021-wartsila-commits-to-carbon-neutrality-by-2030-2995912