Responsible Investment

Effective ways to accelerate the transition towards sustainable investing

October 19, 2011

Image courtesy World Economic Forum

Financial markets have great transformational power to accelerate the transition towards more sustainable business practices and value creation. Recognizing this pivotal role of financial markets, the World Economic Forum has published a report that focuses on the following central question: What are key pathways for investors, corporations, and other key stakeholders in the investment value chain to accelerate the transition towards sustainable investing?

The report has been based on extensive literature research and interviews / workshops with over 150 leading investors and corporate executives. The key findings were presented and discussed at the 2011 Annual Meeting of the World Economic Forum in Davos, Switzerland.

The potential of sustainable investing

Empirical evidence indicates that a sustainable investing approach can lead to better risk-adjusted financial returns. Still, only a small percentage of investors include ESG factors in their investment and ownership decision-making processes. This report argues that sustainable investing has the potential to become a mainstream approach among a broad range of investors. Key drivers include:

  • Growing awareness within the investment community that global mega trends such as climate change and natural resource scarcity (and their related externalities) are becoming increasingly financially material.
  • Increasing demand from large asset owners (as universal owners).
  • Increasing demand from retail investors (including high net worth individuals).

Key barriers to sustainable investing

Specific key barriers are currently inhibiting the transition towards sustainable investing as a mainstream investment approach. The World Economic Forum report analyses them in four categories:

  • Key barriers for investors include: restrictions in conventional valuation models, lack of ESG expertise, lack of awareness and/or scepticism regarding the investment case.
  • Key barriers for corporations include: insufficient integration of sustainability factors into core business strategies, lack of formal approach in setting ESG targets and holding senior staff accountable.
  • Key barriers for investor-corporation interaction include: lack of clarity on which ESG factors are financially material and over which time frame, insufficient communication of link between ESG and corporate financial performance.
  • Key barriers at system-wide level include: disproportionate focus on short-term performance and issues with a near-term impact, and the fact that many negative externalities are underpriced.

How to accelerate the transition towards sustainable investing

To accelerate the transition towards sustainable investing, both functional and mindset changes need to take place. Functional changes include:

  • Where appropriate, linking incentives in the investment value chain more towards superior risk-adjusted financial performance over the long-term – for example, increasing performance assessment periods for fund managers.
  • Including ESG factors as indirect financial performance criteria for corporate executives.
  • Buy- and sell-side analysts working with corporate executives to determine key performance indicators for financially material environmental, social and governance factors at sector level.
  • Asset owners using their mandates to asset managers to encourage the analysis of these factors.

The report also highlights that new mindsets need to be adopted. Examples of new mindsets are:

  • ESG indicators are direct and indirect drivers of business value.
  •  Sustainability considerations – if effectively integrated into core business strategies – have the potential to strengthen the financial performance of companies.

The role of key stakeholders in accelerating the transition towards sustainable investing

The process of transition towards a more mainstream acceptance of sustainable investing is a “chicken-and-egg” situation: more investors will consider ESG information only when more corporations provide it; more corporations will provide ESG information only when more investors demand it.

To accelerate this process of transition, leadership from all stakeholders across and around the investment value chain is required. The World Economic Forum report highlights concrete actions that asset owners, asset managers, corporations, governments, accounting bodies, investment advisers and other key stakeholders can consider undertaking.

Citing

This article may be reproduced according to our terms of use with attribution (and link, if online) to http://www.tias.edu. To be cited as: “Effective ways to accelerate the transition towards sustainable investing”, Bernd Jan Sikken, www.tias.edu, October 19, 2011. 

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World Economic Forum (2011)_Accelerating the Transition towards Sustainable Investing_author Bernd Jan Sikken
World Economic Forum Report

Author(s)

Bernd Jan Sikken
Program Director Finance & Sustainability, Duisenberg school of finance

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