This morning, as I walked my dog, I again found myself questioning the concept of sustainable investing. In the end I concluded that it is not the way to go forward, but rather that we should stop it. Instead, impact investing is the only genuine financial investment driver of enduring change. And I have a few good reasons for thinking this way.
The words ‘sustainable’ and ‘ESG’ in fund names do not necessarily equate to value creation or problem solving. They are over-used and have lost depth of meaning. Sustainable and ESG investing looks backward and evaluates corporate behaviour. The more ESG-related information a company publicly discloses, the higher the score and peer ranking it will earn, and the more likely it will be selected for investment. In other words, a company with ample reporting capacity can ensure it ticks all the boxes. In addition, ESG scores tend most often to be business model agnostic, meaning that a coal mining company can still earn the highest possible score so long it has the relevant policies in place. And vice versa, a renewable energy company that has a business model that actively transitions energy systems away from fossil fuels, but does not have strong policies in place, will likely only achieve a low ESG score.
Impact investing on the other hand, looks to the future and actively seeks to create and accelerate positive change. The big differentiator is intentionality. As impact investors, our starting point is to always look at the challenge we want to address. We see an issue – for example climate change, loss of biodiversity or increasing inequality – and apply a Theory of Change model. We ask ourselves how a potential investment could address the challenges. We thoroughly analyse, applying an impact, risk and return lens. We review mission and purpose, leadership and culture, and of course business and earning models all to determine the fit with our overall impact objectives. Sustainable and ESG investing on the other hand predominantly looks at how well portfolio companies manage their (sustainability) risks, assessing policy and procedures. But quantifying risk doesn’t mean the challenges will be solved.
” investing with the aim of contributing to the authentic and enduring transformative change that the world needs.”
I understand investors’ confusion. Terms like sustainable, ESG and impact are all very nuanced. And the growing number of sustainability labels for funds, each with their own depth of green, is also not helpful. In recent years, the EU introduced the Sustainable Finance Disclosure Regulation (SFDR) with the intention of enhancing the clarity and comparability of sustainability disclosures of investment products. This regulation implemented a classification system for sustainable funds, with Article 6 being considered as mainstream, Article 8 as light green and Article 9 as dark green. There is the expectation that investing in sustainable or ESG funds, which are typically Article 8 funds, will achieve positive impacts. There is also the expectation, or rather the misconception, that these funds are not investing in certain activities like fossil fuels or weapons. In my conversations with investors, I notice that they are becoming more and more aware of the issue and realise that it is not always as straightforward as expected.
It is paramount for investors who want to drive value creation to do their research. This isn’t always easy as it requires access to information, and not all sustainable or ESG funds provide the depth of transparency required to enable comparability that can aid decision-making. Even not with regulation, such as SFDR, in place. In contrast, impact investors are required to track and clearly communicate their impacts. At Triodos Investment Management, we choose to be fully transparent about our investments and the impact we generate, for example on our webpage Impact on a global scale and through our annual impact reports.
My conclusion is that investors need to start thinking more carefully about their own intentions and what they expect of their funds; to question where their money will be directed. Do they want to support companies that may avoid doing harm but mostly are simply managing their risks, or do they want to stimulate forward-looking action that has the potential to solve some of the largest global challenges we face?
Those who truly want to drive enduring transformative change for future generations, I encourage to do in-depth research to better understand ‘what’s under the hood’ of ‘sustainable’ and ‘ESG’ funds and to draw their own conclusions, which I hope will be to stop sustainable investing and to instead start investing with the aim of contributing to authentic and enduring transformative change that the world needs.