Silencing the doubts: the unstoppable rise of sustainable investing

When the ‘Pax World’ investment fund launched in the US in 1971, it became the first broadly diversified, publicly available mutual fund to include social considerations in its investment analysis. Opposed to US involvement in the Vietnam War, the fund’s founders, Luther Tyson and Jack Corbett, took an exclusionary approach, ensuring their fund avoided firms that stood to profit from the war.

Though Pax World was the first such fund, it was part of a long tradition. For more than two centuries, socially responsible investing (SRI) has been used to put pressure on governments and businesses to create change. In 1841, Lombard Odier was part of a move to divest from firms that benefitted from the transatlantic slave trade. More recently, an international disinvestment movement, that began with activists then spread to governments, played a key role in ending apartheid in South Africa.

Sustainable investing – which aims to achieve market outperformance while building a socially and environmentally sustainable economic model – is the latest in this tradition of using the power of finance to tackle the biggest issues of our time. Yet, even as global temperatures reach a new record¹, and unprecedented biodiversity loss threatens a domino effect of further loss², sustainable investing is being questioned. A combination of forces – from politics to macroeconomics – is demanding investors decide: Has sustainable investing had its day, or are recent disruptions merely short-term blips in a long-term trend towards building a net-zero, nature-positive and inclusive economy?

Green-lash

In January 2021, in one of his first acts as President, Joe Biden took the US back into the landmark Paris Agreement. Soon after, he proposed what was to become the Inflation Reduction Act (IRA), a huge package of tax incentives, grants and loans which included nearly USD 400 billion for clean energy projects³.

At around the same time, the European Union agreed the European Green Deal, a wide-ranging set of measures that aim to achieve carbon neutrality across the entire EU bloc by 2050, described by Ursula von der Leyen, President of the EU Commission, as “Europe’s man on the moon moment.⁴”

Today, however, the political landscape looks very different. In the US, the spectre of a second term for former President Donald Trump could mean withdrawal from the Paris Agreement and a hatchet to the IRA⁵. In Europe, resistance to sustainable policies – dubbed a ‘green-lash’ – led the EU to scrap its plan to halve pesticide use⁶ and remove a requirement on the agricultural sector to cut non-CO₂ emissions by 30%⁷.

Market conditions and macroeconomics

Meanwhile, market conditions and macroeconomics have hit renewable energy projects, often seen as flagship sustainable investments. Recent high inflation and interest rates have combined with supply chain bottlenecks to push up the cost of new renewables projects, threatening developers with losses. In the three years to date, the S&P Global Clean Energy Index, which indicates the performance of the renewables industry, has fallen by around 16%⁸.

Fears around greenwashing have created further investor jitters. Last year, DWS, Germany’s largest asset manager, reached an out-of-court settlement of USD 25 million to end a probe into inflated claims about the sustainability of its investments.⁹

Some of the world’s largest asset managers have now rowed back on their sustainability commitments. In 2023, Vanguard left the Net Zero Asset Managers initiative¹⁰, while earlier this year, JP Morgan Asset Management and State Street Global Advisors both withdrew from Climate Action 100+¹¹. As jitters have grown, the EU’s most rigorous sustainable investment fund class, known as Article 9, has seen three consecutive quarters of withdrawals¹².

The bigger picture

For investors, these concerns are understandable – however, it is essential to step back from this short-term noise to see the bigger picture. For example, in our energy systems, every year for more than two decades the global community has added more renewable energy capacity than has ever been achieved before. Last year, even as high inflation hit the sector, nearly 510 GW of new renewable energy capacity came online, an almost 50% increase on that added in 2022.

Though this rapid growth is now market-driven, with plunging costs and economies of scale spurring uptake, this does not mean the investment story has been a one-way street. Despite unprecedented and still-rising demand, many solar panel manufacturers have struggled to stay profitable,¹³ as a supply glut and strong competition – especially from Chinese firms, who are strongly supported by central government¹⁴ – have squeezed profit margins.

The lesson is that as adoption rises, sustainability-focussed technologies become a product like any other. Returns will not be achieved with a ‘blanket bet’, but through a thorough understanding of the deep systems changes taking place in our economy and the myriad new opportunities being created – such as the vast grid infrastructure build-out underway as new wind and solar installations come online. Recent headwinds may have concealed the bigger picture, but the energy transition is continuing to accelerate, and neither macroeconomic fluctuations nor short-term political positioning will be able to stand against the tide.

Read also: Energy’s forgotten giant – grid infrastructure plays catch-up as renewables gather pace

Investing in nature

Whilst electrification is being driven by technological innovation and economies of scale, the rise of nature-based investments is being driven, at least in part, directly by the threat of climate change. Across the world, key agricultural products are under unprecedented pressure from rising temperatures and the growing risk of droughts and floods.

From oranges in Brazil to staples like soybeans, rice and potatoes – climate change is now hitting yields and threatening persistent annual food inflation of above 3%¹⁵. Earlier this year, following dry weather in West Africa, the market price for cocoa reached a record high¹⁶; while coffee could see similar price pressures in years to come, with its total suitable growing area set to fall more than 50% by 2050¹⁷.

Together, the total value of the tea, coffee, cocoa, rice and soybean markets is USD 1.2 trillion.¹⁸ According to Morten Rossé, Head of Nature and Climate at Lombard Odier Investment Managers, the sheer scale of the food commodity sector means investors are likely to see huge changes in finance flows, as food producers switch from conventional monoculture crop production to more climate-resilient nature-based models.

“We have made a system where we have taken much of our production out of nature, out of forests,” he explains. “What we are proposing is to bring nature back into production systems. This will make them better at adapting to climate change. If we invest in nature then we enhance the value of the products being produced, and we can also appreciate the value of the land over time.”

Some of the world’s biggest food producers are already making the switch. Paul Bulcke, chairman of multi-national Nestlé, which has pledged to source 50% of its key ingredients from regenerative agriculture by 2030, says, “We know that regenerative agriculture plays a critical role in improving soil health, restoring water cycles and increasing biodiversity for the long term. These outcomes form the foundation of sustainable food production.”

Regulation and geopolitics

Though short-term politics appears to have turned against ‘green policy’ in some regions, the broader picture and longer-term trend remains unchanged – for both pragmatic and ethical reasons, policy is continuing to bolster the sustainability transition.

In Brazil, for instance, a new ‘Ecological Transformation Plan’ will use payments for environmental services to incentivise nature restoration and preservation, aiming to foster economic growth and create jobs.¹⁹ While in the EU, the REPowerEU plan is mobilising EUR 300 billion to ensure domestic energy security by accelerating the rollout of wind and solar electricity generation;²⁰ and from 2025 onwards, the bloc will require that all palm oil, soy, cattle, coffee, cocoa, timber and rubber, as well as derived products, must be certified deforestation free.²¹

The direction of travel is also clear for corporates. In Europe and the UK, to ensure transparency for investors and regulators, all public or large private companies are now obliged to disclose their climate impact and the commercial risks and opportunities created by climate change – in the US, the SEC has proposed similar legislation. From this year onwards, the EU law will also require firms to report on their biodiversity impact.

Sustainability is altering the risk and return profile of financial market investments. For investors, it is about being exposed to tomorrow’s economy

A long-term, structural transformation

According to Michael Urban, Chief Sustainability Strategist at Lombard Odier Investment Managers, sustainable investing has become essential for managing risk and targeting market outperformance: “Sustainability is altering the risk and return profile of financial market investments. For investors, it is about being exposed to tomorrow’s economy.”

At the same time, he explains, “Investing green does not automatically mean green returns.” The key, he says, is to understand the deep systems changes that are driving the transition. “Essentially we’re talking about a complete rewiring of economic activity. It’s across every single sector you can think of.”

“Crucially, the transition itself is not cyclical – it’s a long-term structural transformation in the way we conduct economic activity and produce growth. It’s been in the making now for at least twenty years, and it’s going to continue to unfold over a number of decades. Can it be stopped? It’s true that it’s going to go through phases of acceleration and slow down, but for the long-term the momentum is such that it has become unstoppable.”