Solar investment advisory

Quarterly essay

Quarterly essay QII 2009

The unconventional success of sustainable investing

Cary Krosinsky and Nick Robins*

As the economic crisis has deepened, many have turned to the ideas of John Maynard Keynes to provide a route map out of recession. But less attention has been paid to Keynes equally important prescriptions for the investment industry, derived from his time in the City as investor and insurance executive. Writing in the depths of the 1930s depression, Keynes observed from bitter experience that “it is the long-term investor, he who most promotes the public interest, who will in practice come in for the most criticism wherever investment funds are managed by committees or boards or banks”. Today, investment short-termism has not only been one of the underlying drivers of the current financial crisis, but also risks wider environmental catastrophe, not least in the looming threat of uncontrolled climate change.

Keynes’ ghost, however, could take heart from the rapid rise and performance of sustainable investing strategies over the past decade. Emerging in the late 1980s among a handful of European fund managers led by Jupiter and Sarasin, sustainable investing has spread to cover all assets and regions. Building on the earlier ethical and socially responsible investing movements, sustainable investing for us combines two profound appreciations. The first is that the best way of generating risk-adjusted returns in the 21st century is to fully incorporate long-term environmental, social and economic trends into investment and ownership decision-making. The second is that achieving global sustainability goals requires the mobilisation and recasting of the world’s capital markets. If the first speaks the language of financial value at the micro-level, the second refers to the imperative of structural reform at the macro-dimension.

Sustainable investing provides an agenda for action for purely financially motivated investors eager to mitigate risk and benefit from upside opportunities as well as for civil society organizations aiming to achieve social and environmental progress. It encompasses the growing numbers of individual investors who wish to ensure that social and environmental factors are included in the ways they allocate their savings. It also draws on the rising tide of institutional investors in pension funds who appreciate the growing financial materiality of environmental, social and governance (ESG) factors. Added to this are clean tech investors who have identified major potential for capital growth in companies providing solutions for the low carbon economy. What unites these apparently disparate groups is an acknowledgement that lasting value can now only be created through fresh approaches to financial analysis, fiduciary duty and capital market regulation.

Investment is about anticipation, and sustainable investors have been first to appreciate the financial materiality of carbon exposure, in the process getting ahead of the electronic herd, which is now rapidly trying to catch up. This is not just a matter of fine-sounding words, but has been demonstrated through fund performance. In an innovative piece of research published in our book, we have shown that the world’s sustainable investing equity funds outperformed the MSCI World, S&P500 and the FTSE100 on a 1, 3 and 5 year basis to the end of 2007; these funds also outperformed purely ethical portfolios . Importantly, the analysis also shows that time horizons matter, with funds with low turnover substantially outperforming those with high velocity trading rather than ownership strategies . Clearly, the credit crunch and accelerating economic downturn have knocked the share prices and immediate prospects of many clean energy stocks that feature in sustainable investing portfolios.

Yet, the fundamentals underlying sustainable investing remain strong. The science behind climate change continues to get ever-more bearish. Job creation has now been added to carbon concerns and energy security as a politically popular driver of renewable energy and energy efficiency policies. And action along the investment chain is starting to pick up speed, symbolised by the recent Investor Statement on a Global Agreement on Climate Change. Backed by USD6 trillion of assets, the statement was supported by 135 investors including pension giants such as APG, CalPERS, CalSTRS, New York, Norges Bank, and PGGM, as well as fund managers such as Black Rock, BNP Paribas, HSBC, PRUPIM and Schroders, and called for the measures necessary to “provide a stable investment climate supportive of the transformation to a low carbon economy”.

The next five years are likely to be among the most tumultuous to date for sustainable investment. The task ahead is to create capital markets that are ‘fit for purpose’ for the social, economic and environmental realities of the 21st century. This means updating the listing and disclosure rules on the world’s stock and credit markets, as Aviva’s Chief Executive Officer Alain Dromer has recently suggested. It means refocusing the incentives for investment analysts and fund managers away from ephemeral gains in short-term trading towards steady and reliable returns over the long-term. It means redirecting the ingenuity of capital markets so that they serve rather than smother the public good – for example, designing the instruments that can accelerate the financing of urgently needed environmental infrastructure. And links between institutional investors and civil society need to be rebuilt not least to restore public trust in financial markets.

During the dark days of the 20th century’s Great Depression, Keynes lamented the the odds that were stacked against the long-term investor. “It is in the essence of his behaviour that he should be eccentric, unconventional and rash in the eyes of average opinion”, Keynes wrote, adding that “if he is successful, that will only confirm the general belief in his rashness; and if in the short run he is unsuccessful, which is very likely, he will not receive much mercy. Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally”. Sustainable investing has served its apprenticeship. It is time for its ‘unconventional success’ to become the new investment mainstream.

* Cary Krosinsky and Nick Robins are co-editors of Sustainable Investing: The Art of Long-Term Performance (Earthscan, 2008)