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ESG Investing Grows Up
Investing in responsible companies has improved dramatically over the past 20 years, but it still requires continuous attention to detail.
Investing in companies that have strong environmental, social and governance (ESG) records has expanded dramatically over the past two decades. In 1995, when I was at the World Bank, fewer than 60 funds engaged in this new form of investing, collectively managing only about $12 billion in assets. Now there are hundreds of high-quality ESG and impact funds, overseeing hundreds of billions of dollars in assets. That represents a major advance, even though these funds still make up a small proportion of total assets under management.
Foundation heads and university presidents and boards and their investment committees, as well as other institutional investors, increasingly agree that impact and ESG investing can enhance, rather than constrain, returns. At its core this sector is about managing a risk or seizing an opportunity. Its never a one-size-fits-all exercise.
Still, many companies dont practice what they preach. Eager to attract funds from social-impact investors, they may employ ESG officers to improve their ESG index scores, even while producing coal or using cheap labor in countries with poor human-rights records. As a result, investors must keep a sharp focus on environmental sustainability, governance and ethics in their own research; they cant rely only on the indexes. This requires careful balancing of pros and cons, especially when government authorities are major sponsors of renewables projects. For example, China produces the most carbon dioxide from coal-fired power plants of any country, yet it is also among the most aggressive in promoting renewable-energy projects in solar and wind power.
The rapid expansion of impact investing has, predictably, created more complexity and challenges for investors. CEOs of well-managed operating companies such as Unilever, as well as heads of investment management firms, have responded, making clear what sustainable investing means to them and what investors should expect over longer time periods.
The best investors whether companies, hedge funds or private equity firms typically have excellent governance principles and practices. They focus on long-term value creation, high standards for transparency and integrity in their processes and communications.
One big problem for investors interested in sustainable or impact investing is the lack of robust tools and comprehensive, easy-to-use databases to identify the right opportunities. The proliferation of indexes using different standards makes it even more difficult to navigate and integrate meaningful investments.
My experience in impact investing in the early 1990s, when I was managing energy and renewable- and clean-energy investments at the World Bank, was eye-opening given the complexity of the then-current technology and its high costs. When I founded and led a new natural-gas financing and investments group to replace coal, we managed to increase investments in this area significantly. However, when I led the group responsible for developing best-practice policies and projects for renewable energy, the complexity and large maintenance costs were prohibitive.
At the Bank we were early advocates and funders for carbon abatement projects, such as substituting natural gas for coal in China and Bangladesh. We worked with governments and investors in emerging-markets countries to develop policies and create projects in renewable and clean energy. Although we were too early and the cost of the technology was often high, these initiatives were important in laying the groundwork for current investments in solar and wind.
My World Bank experience taught me another important lesson: Successful impact and ESG investing requires continuous attention to assessing risks and opportunities because of the many variables at play in each situation. Policymakers, CEOs and investors today must push the limits of their capabilities.
To be sure, the appeal of renewable-energy projects has not waned in this period of low energy costs. There is no reason to believe that innovation in renewables technology will falter over time. Innovation in reducing the expense of sustainable energy and improving battery life and storage will continue to improve efficiency and productivity of renewables and reduce costs trends that bode well for achieving favorable long-term returns.
Afsaneh Beschloss is founder and CEO of Washington-based global investment and advisory firm Rock Creek Group.