Investors can be powerful change agents when it comes to the environment. Investors have capital which they can allocate in ways that either help or hurt the environment. They also have significant influence with the companies they invest in and with policymakers globally, both critical stakeholders when it comes to improving the environment.
While some investors are already working at the nexus of the environment and finance, given the earth’s pressing environmental challenges like climate change, overfishing and deforestation, there has never been a greater need for all investors to engage on sustainability issues. For example, private capital will be essential in order to mitigate the worst impacts of climate change – a recent UN study estimated that it will require roughly $90 trillion dollars, much more than philanthropic or public (i.e., government) investments can fund.
Of course, investors should consider environmental issues not just to do good, but also because the returns often meet if not exceed the performance of more traditional investments. And because investors are interested in risk-adjusted returns, managing environmental risks like carbon and water is critical to any comprehensive investment process.
Below are three levers investors can use to when considering environmental impacts:
- Capital allocation – The first decision any investor must make is where to invest their money. Considering sustainability issues can help drive capital towards investments that provide both an environmental and financial dividend.
One way to allocate capital toward more sustainable investments is to integrate environmental criteria into the investment process. Organizations like Carbon Disclosure Project (CDP) and Sustainability Accounting Standards Board (SASB) improve disclosure on issues like carbon emissions and water, enabling investors to gain insight into how efficiently a company operates and manages environmental risk. In this respect, as Environmental, Social and Governance (ESG) disclosure improves, investors can move from screening out whole sectors to proactively allocating capital toward companies that better manage material environmental issues, an investment trend which is becoming more mainstream in the U.S. For example, while Environmental Defense Fund’s (EDF) Rising Risk report found methane disclosure in the oil and gas industry to be poor, as methane data improves, investors will be able to shift capital to those operators who are actively managing risk from this powerful pollutant and wasted product.
Investors can also place their money into investments with an explicit environmental component, like green bonds. These bonds are a debt instrument specifically tied to achieving a beneficial environmental outcome like energy efficiency, climate resiliency, or water infrastructure. The market for these double bottom line investments has grown from less than $3b just a few years ago to over $40b in 2015.
Investors are gaining new opportunities to invest in innovative products that help to reduce carbon emissions from deforestation and agriculture and improve sustainable fishing practices around the globe. Sustainable investing is also no longer just for sophisticated institutional investors. As financial tech startups are enabling individual retail investors to invest in an environmentally-friendly manner – giving all an opportunity to do well by doing good.
- Company engagement – Once their money is allocated, investors can then use their influence as equity or debt-holders to hold corporations accountable for environmental performance, risk management and disclosure. Organizations like Principles for Responsible Investment (PRI) and Interfaith Center on Corporate Responsibility (ICCR) act to help investors be effective engagers by coordinating efforts on topics from deforestation and palm oil to water risks, and encourage collaboration where possible.
Engagement can include the ability of asset owners like private equity to work with portfolio companies to become more sustainable. EDF worked with leading private equity companies to design the Green Returns tool, which enables private equity to approach value creation through an environmental lens, and spot opportunities such as energy efficiency and waste reduction initiatives that generate cost-savings. Using this tool, Kohlberg Kravis Roberts (KKR) was able to add $1.2 billion to the value of their portfolio while avoiding significant greenhouse gases, water use, and excess waste.
Shareholders in public companies also have the ability to file shareholder resolutions to publically encourage better environmental management. In 2016, shareholders filed a record number of climate-related resolutions, which a recent Harvard Business School study has shown to be effective in improving both financial and environmental performance when focused on material ESG issues.
- Policy Support – Getting the rules right will be critical in both addressing environmental issues directly and in driving private capital towards environmentally-friendly assets. As Hank Paulson, the former Treasury Secretary and CEO of Goldman Sachs noted in a recent NY Times Op-Ed, we need policies that “include environmental regulations to stimulate clean, sustainable development; incentives and subsidies for clean energy investments; and the pricing of carbon emissions.”
Investors with expertise on business, markets, and finance have an important role to play in the policy process. The next generation of investor leadership on sustainability will require aligning external policy positions with internal sustainability practices and playing a proactive and public role to support legislation and regulations.
Organizations like CERES have been instrumental in activating investors on policy matters. Just this year, CERES played a leading role in getting 76 global investors with $3.6 trillion in assets under management (AUM) to support methane regulations in the U.S. and Canada while working with organizations like Institutional Investors Group on Climate Change (IIGCC) in Europe to recruit 130 investors with $13 trillion in AUM to support implementation of the Paris agreement. Such statements of support are meaningful in helping build the business case for environmental policy. And direct engagement with law and policy makers is a next frontier for investors looking to maximize their impact on supporting sound policy development.
The need for investors to engage on environmental issues has never been greater, and the opportunities to do so profitably have never been more widespread. Investors of all kinds should incorporate the levers of allocation, engagement and policy in their investment process – a move with the potential to benefit both the planet and their portfolios.
Follow Sean Wright on Twitter, @SeanWright23
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