What is sustainable investing?

Sustainable investment definition

Despite this being a modern phrase, conceptually it goes back many decades, if not further, and has also been known as responsible investing, ethical investing, socially responsible investing and even green investing.

A sustainable world is one in which benefits can be provided today without sacrificing our future environment, social well-being and health. Achieving this means tackling some very serious challenges, such as climate change, poverty, inequality, discrimination and hunger.

This requires investors to look at the companies in which they might invest – whether by buying shares or their debt (bonds) – through a lens that shows more than just profits. Sustainable investors will look at what impacts a company has on the environment and society, including its goods and services and its everyday operations. How does it treat its employees and other key stakeholders? And even if it meets the required standards of sustainability, what about its suppliers and customers?

It is important for investors to remember that improving the world does not preclude making excellent returns: Liontrust’s Sustainable Investment team believes companies that will thrive are those that improve people’s quality of life, increase the efficiency with which we use scarce resources and enhance the safety of human activities.

The history and growth of sustainable investing

Sustainable investing is an increasingly prevalent theme in modern-day investing, having evolved and gathered momentum in the last few decades. Arguably, the Covid pandemic was a catalyst that made people even more conscious of social justice and preserving our environment. It raised awareness of how fragile our world and society can be and how important it is for us all to work towards preserving and improving these.

At one stage, ethical investing involved negatively screening companies – if they were deemed to be ‘unethical’ according to an investor’s viewpoint then they would be excluded from portfolios. Today, however, sustainable investing can involve more than this, with investors increasingly demanding that the companies in which they invest make a positive environmental, social or governance (ESG) impact.

‘Impact investing’ can use a variety of criteria to measure such positive outcomes, including the 17 Sustainable Development Goals (SDGs) established by the United Nations in 2015. The SDGs, also known as the Global Goals, are a call to action to end poverty, protect the planet and ensure that all people have peace and prosperity by 2030. They cover a range of interlinked ESG objectives and recognise that action in one area will affect outcomes in others and that development must balance social, economic and environmental sustainability.

Sustainable investing has evolved in other ways, too. Negative screening was originally applied just to equities, for example with ethical investment funds. Now, however, companies are increasingly offering bond options to help investors meet their sustainable investing goals. So far, the most prevalent option available has been ‘green bonds’, which tick the ‘E’ in ESG. The market for green bonds has grown exponentially. The first green bond was issued in 2007 and the volume of cumulative issuance surpassed the $1 trillion milestone in December 2020 (Source: Climate Bonds Initiative Explaining green bonds | Climate Bonds Initiative). But social and governance-linked bonds are also becoming more widely available, albeit from a relatively nascent position at present.

In terms of geographic spread, the application of ESG principles has been most prevalent in developed economies, and especially Europe. However, sustainable investing is being more widely adopted. Some emerging markets, for example, are acutely aware of the importance of tackling climate change because they are disproportionately impacted by it and prioritise tackling carbon emissions in their decision-making. The Middle East has also been investing for some time in Islamic finance funds that comply with the ethics outlined in Shariah law.

Liontrust believes interest in sustainable investing can only grow as millennials inherit and generate increasing levels of wealth and expect companies to adopt more responsible behaviour. Research we commissioned in 2021 found that 72% of discretionary fund managers and advisers said the proportion of clients investing sustainably had increased in the previous 12 months, compared to 59% in November 2019, and 77% of those questioned expected a further increase in the next 12 months. As for private investors, 75% said sustainability is important in their everyday lives but of these, only 51% said they were investing sustainably.

Beyond this growing consumer demand, we see two other factors behind the growth in sustainable investing. First is a basic financial sense, with regulations and legislation increasing costs for polluting companies and providing significant impetus for efficiency improvements. Second is the political climate: the environment and related social impacts are now widely regarded as mainstream issues with policy decisions increasingly made with sustainability in mind. This political will has a marked effect on regulation in areas like carbon emissions, which in turn affects the competitive landscape for businesses.

The advantages of sustainable investing

There are numerous advantages of sustainable investing. The many billions that investors put into sustainable investing funds every year are used to achieve innumerable positive outcomes for the environment and society. For example, if investors want to help preserve the environment by promoting renewable energy development or wish to support healthcare in developing countries, then they can invest in companies that do so.

Investors can also use their influence to bring about better corporate behaviour. By actively engaging with companies, both at shareholder meetings and directly with senior managers, they can encourage and put pressure on companies to take greater account of ESG in their products, service and actions. For example, as part of its ongoing engagement with companies, the Liontrust Sustainable Investment team has challenged the companies in which it invests to be more ambitious in terms of their decarbonisation targets, launching the 1.5 Degree Transition Challenge in 2020 in line with the target laid down by the Paris Agreement of 2015.

Academic studies have shown that companies that are improving their ESG scores can outperform. For example, a study by Rockefeller Asset Management in 2021 found that ‘ESG Improvers’ offered the potential to generate ‘uncorrelated alpha’ – or market-beating performance - over the long term (source: UNPRI; ESG Improvers - an alpha enhancing factor | Case study | PRI (unpri.org).

Investing sustainably can also reduce risk. Regulators are coming down ever harder on corporate malpractices. Investing with companies that have a responsible approach to ESG can significantly reduce the regulatory risk of fines and legal penalties, as well as the reputational risk caused by adverse media coverage.

Meeting investors’ sustainable objectives

Investors need to ensure their investments do meet their sustainability goals.

Investors have different views on what sustainable investing should be and what their priorities are. For example, one investor might regard armament companies as immoral, yet another might regard them as being necessary and providing societal benefits.

Even when investors are clear on what their sustainability goals are, they then have the challenge of matching investments to them and monitoring the investments on an ongoing basis to ensure that what is promised is indeed delivered. ‘Greenwashing’, for example, is a term commonly used now to describe investments that do not live up to their environmentally friendly investing claims.

Several services offering ESG ratings are available to help investors assess their investments, but these can be complex and sometimes provide differing interpretations.

Types of sustainable investment

Sustainability has been increasingly integrated into investment products to meet the growing demand from investors.

Many listed companies in developed economies now make a point of declaring their ESG credentials because they know investors expect this.

Companies can also raise finance using bonds. In recent years, these have been issued by companies with an ESG flavour. Green bonds, for example, raise funds for environmental investment projects, such as wind farms. The company that issues them does not necessarily have to be that green. For example, an oil company might still issue a green bond to raise cash for eco-friendly investments, such as renewable energy projects.

How to invest in a sustainable investment fund

Investors must first be clear about what their own financial and sustainability goals are.

Individual investors may wish to select funds to construct portfolios themselves or seek the advice of professional financial advisers.

As more funds launch into the sustainable investing market with an array of names and approaches, it is important for investors to assess the key features and match these with their own goals.

A key hazard for investors though is to identify ‘greenwashing’ in practice: where groups are talking up their credentials in this space without the expertise or track record to back it up.

Liontrust has produced a list of five ways to tell whether funds, and the teams behind them, are capable of meeting investors’ sustainable expectations. These include:

• Transparency. Genuinely sustainable fund managers should be transparent about how they invest, as well as being open to challenges. This should include clear and simple information explaining how they run money: what companies they look for under the sustainable approach and what they avoid. It should not be generic greenwash, with little more than meaningless ‘brochure’ comments like “sustainability is in our DNA”. Anyone can write a report on climate change, for example, but how are funds positioned given the huge challenges that combatting this will entail?
• Experience and resource. As in any walk of life, experience and depth of a team are important when it comes to sustainable investing. We have a 13-strong team and 20 years of experience running sustainable funds.
• Knowledge and training. Sustainable investing is a specialist area and subjects like climate change are fast moving so investors need to be confident their managers have the required knowledge to run money in this way. This can be anything from members of a team having specialist qualifications to a general focus on training to ensure people understand the latest sustainability trends.
• Activism. Engagement is a key part of what we call sustainable investing. We feel managers should be able to highlight a track record of holding companies to account and encouraging them to improve. Managers should be able to talk in detail about their engagement priorities – whether diversity, tax transparency or plastic pollution – rather than making sweeping statements. It is worth looking at managers’ AGM voting records: do they vote with company management or actually challenge the businesses in which they invest to improve?
• Evidence. Ultimately investors are looking for all this knowledge and experience in sustainability being applied to investment decisions – giving meaningfully different exposure compared to more conventional funds. Are managers able to show how their views are reflected in their decisions: is it simply ESG data and reporting for the sake of it or making a genuine difference to investment?

Liontrust’s sustainable investing opportunities

For more than two decades, the Liontrust Sustainable Future Funds have sought to generate strong returns from investing in companies aiming to deliver profits through positive social and environmental impacts. The fund managers look at the world through the prism of three mega trends – Better resource efficiency (cleaner), Improved health (healthier) and Greater safety and resilience (safer) – and then 20 themes within these.

If a company has significant exposure to one of the themes, the fund managers verify how sustainable the rest of its activities are. For each company, the fund managers determine the ESG factors that are important indicators of future success and assess how well these are managed, via he proprietary Liontrust Sustainability Matrix.

Companies in which the fund managers invest will have robust business fundamentals with a proven ability to deliver high returns of equity (RoE) through sustaining margins and asset turnover. Typically, these companies have a maintainable competitive advantage through scale, technology or business model.

The fund managers invest in well-run companies:

• Whose products and operations capitalise on the transformative changes the Liontrust Sustainable Investment team has highlighted.
• May benefit financially from these transformative changes and score well on ESG, business fundamentals and valuation criteria.

The managers believe identifying these powerful themes and investing in exposed companies can make for attractive and sustainable investments.

Sustainable investing is not only for those who want their investments to “do good”: there is a compelling case for all investors to take this approach and it is possible to make profits and have a positive impact.

For more information on the Liontrust Sustainable Future investment funds, see: Sustainable Investment Team.

KEY RISKS

Past performance is not a guide to future performance. The value of an investment and the income generated from it can fall as well as rise and is not guaranteed. You may get back less than you originally invested.

The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.

Investment in Funds managed by the Sustainable Future team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The value of fixed income securities will fall if the issuer is unable to repay its debt or has its credit rating reduced. Generally, the higher the perceived credit risk of the issuer, the higher the rate of interest. Some Funds may invest in derivatives. The use of derivatives may create leverage or gearing. A relatively small movement in the value of a derivative's underlying investment may have a larger impact, positive or negative, on the value of a fund than if the underlying investment was held instead.

DISCLAIMER

This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID), which provide full product details including investment charges and risks. These documents can be obtained, free of charge, from www.liontrust.co.uk or direct from Liontrust. Always research your own investments. If you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances.

This should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy. The investment being promoted is for units in a fund, not directly in the underlying assets. It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, forwarded, reproduced, divulged or otherwise distributed in any form whether by way of fax, email, oral or otherwise, in whole or in part without the express and prior written consent of Liontrust.