Investing in the transition to a sustainable economy
We recognised the coming changes more than two decades ago when we launched our first thematic investment strategy, which focuses on companies providing water solutions and environmental services. We understood that to be a responsible actor in the economy also made good business sense. Our franchise of such “deep-green” strategies has expanded since, leading the industry today by assets under management .
We are standing on the cusp of what will prove to be as significant as the Industrial Revolution, when innovations like the steam engine and the cotton gin transformed everything from transportation to energy production. Except now, the speed of innovation and its dissemination, together with the urgent need to decarbonise the global economy, has amplified the investment opportunities exponentially. For investors like us, nothing could be more exciting.
But the transition isn’t just about cutting edge innovation. Existing companies adapting to this new environment offer investors an enormous range of opportunities. How these companies manage the adjustment with respect to environmental, social and governance (ESG) considerations will determine how the market values them. This will inevitably make for winners and losers as well as leaders and laggards within each sector across the economy. As investors, it is our job to identify and distinguish the former from the latter and allocate capital accordingly.
As always, diversification is key. There is a long line of examples of the perils of putting too many eggs in one investment basket. By contrast, investors focusing on the sustainable transition have a rich field from which to diversify their holdings – across all geographies and asset classes, from venture capital and private equity start-ups to real estate, where the world’s existing building stock will need retrofitting, from listed equities to bonds with sustainability covenants.
These opportunities aren’t restricted to developed markets. For instance, emerging markets lead the worldin sustainable bond issuance, with some countries like Chile having issued no conventional, hard currency bonds since 2020, instead focusing purely on labelled debt within hard currency issuances. Such labelled-debt instruments include green, social and sustainability-linked bonds, which accounted for one-fifth of new emerging-market sovereign bond issuance in 2021.
Investors aren’t just helping drive this change for the better through how they allocate capital. They’re also doing so by practicing active ownership – using proxy voting and directdialogue with corporate management to facilitate an accelerated transition, while at the same time potentially adding financial value to their investments. Investors are taking this role seriously. For example, bond investors have increased such interventions in recent years, even though as a class of investor they lack voting rights. Research shows that engagement is more effective than exclusion in not only influencing corporate management decisions but also in driving higher returns. It is also how investors in publicly-listed issuances can come closest to capturing private-equity like transformation premia, thereby providing an additional source of alpha. This is particularly true when investors collaborate on engagement, which increases the likelihood of realising desired outcomes.
Indeed, collaborative engagement has proven to be a key lever for investors to drive real impact in public markets. That such collaborations go beyond the financial industry makes them even more powerful. Perhaps the best know such initiative, Climate Action 100+, was designed by a consortium of investor networks consisting of non-profit organisations, asset owners, investors and intergovernmental organisations from around the world, coming together to persuade the largest corporate greenhouse-gas emitters to align their businesses with the Paris Agreement goals. Six years on, Climate Action 100+ has secured a number of ground-breaking commitments. Similar initiatives have now been launched or are underway for water and nature more broadly. Together, we are truly better.
Collaborations like these can also apply beyond financial markets, to positively influence policy, regulation and research towards accelerating the sustainable transition. Initiatives like Building Bridges, which was born here Switzerland, seek to bring private and public sector actors together to better align finance with sustainability outcomes. And there are other partnerships, like the MISTRA Finance to Revive Biodiversity programme, which brings the academic and financial spheres together to research how the financial sector can contribute to a nature-positive economy. We all need to be rowing in the same direction if we have any chance of reaching a safe harbour.
While rich with opportunities, transitions also present potential for new risks. We have started exploring such potential transition risks with the Institute of International Finance. One is debt risk, as growing debt burdens hit national balance sheets already strained by the pandemic. Another is inflation, as energy prices drift upwards due to heightened policy and regulation intended to deter carbon emissions. And finally there is the risk of asset bubbles, if capital is over allocated to mismanaged projects. But while we must continue to monitor for and stay vigilant about these risks as well as the already real greenwashing one, we must not let potential risk paralyse us from identifying and prudently seizing transition opportunities.
As directors of capital and influence, asset owners and managers have the responsibility of embracing the transition to a sustainable and more resilient economy. But this also opens for us opportunities. No single actor or segment of society can make this happen alone, we all must work towards the same objective. The economy of the future will need intelligent, incentive-driven regulatory frameworks and policies that align with the needs of civil society. New collaborations will be essential to these changes. These changes have already begun. I am convinced that navigating the journey with an attitude that is both responsible and seeks sensible opportunities is the only way forward.