SINGAPORE (Dec 31): There is currently some US$24 trillion ($33 trillion) in sustainable investing — or investment strategies that take into account environmental, social and governance (ESG) standards while earning returns. The amount under management represents nearly one-third of the total value of stocks traded on the world’s major stock exchanges last year. And, by most estimates, this investment field is only going to grow. But it faces challenges, namely how to measure the actual impact that such investments have had, on the environment or the community, for instance.

From a sustainability point of view, the support for the sector has certainly been robust. Most recently, Larry Fink, CEO of the world’s largest asset manager BlackRock, announced that he wanted to be a global powerhouse in sustainable investing. BlackRock recently launched its first ESG bond fund.

Meanwhile, major fund houses Standard Life Aberdeen, Columbia Threadneedle Investments and AllianceBernstein Holding have teamed up with The Big Issue, a magazine sold by homeless people. Together, they are building a blockchain-enabled platform to offer 30 to 40 impact funds to investors.

UBS Group launched a 100% sustainable, cross-asset portfolio in April, mixing corporate bonds issued by ESG leaders to World Bank bonds, companies that are leading in ESG issues and other financial products.

The following month in Singapore, former executive chairman of Templeton Emerging Market Group Mark Mobius launched an open-ended fund to help companies in frontier markets improve corporate governance standards. The fund, under Mobius Capital Partners, has a seed capital of US$30 million and targets to grow to US$1 billion in two years.

Credit Suisse Group’s US$55 million Asia Impact Investment Fund, which it launched in 2016 with UOB Venture Management, backed by wealthy Asian individuals, has made 10 investments to solve bottom-of-the-pyramid problems — or problems afflicting the poorest two-thirds of the economic human pyramid — in Asia.

Indeed, fund managers say they expect to see wider adoption of sustainable investing products among Asian private investors. And that could spur some sophistication in the types of sustainable investing products in the market. Asset managers would have to go beyond simply filtering out companies with the worst ESG standards or companies in loosely categorised sectors.

“A few years ago, we saw most investor demand in the region in thematic equity funds that focus on themes such as water or clean energy,” says Mario Knoepfel, head of sustainable investing advisory for Asia-Pacific at UBS Global Wealth Management. But investors have since expanded their scope of sustainable investments.

“We have seen strong pickup in liquid strategies focusing on integration of ESG aspects into the investment process, aiming to achieve better risk-adjusted performance,” Knoepfel adds.

Developing strategies

Currently, screening to exclude companies that are deemed to have low ESG standards is the most popular, and arguably the easiest, strategy in the sustainable investing universe. It covers US$15 trillion of investments worldwide. Another strategy — using ESG factors to construct a portfolio — accounts for about US$10 trillion in investments globally.

Impact investing — defined as driving social and environmental change while making financial gains — will be another popular sector to watch, according to observers. The Global Impact Investment Network projects the impact investing sector to be worth about US$220 billion today. “Our Asian clients have been highly receptive to these opportunities and were the biggest investors in these solutions,” says Knoepfel.

UBS has raised US$470 million for its UBS Oncology Impact Fund and is the largest investor in TPG’s The Rise Fund last year. The latter aims to address the UN Sustainable Development Goals in healthcare, education, clean energy and food.

As various clean technologies mature, some fund managers expect more products to be added to the sustainable investing field. “Some of the key positive technologies such as wind and solar have matured to the extent there is a decent universe of large and investable companies. The maturity of the market has shifted the momentum for this sector from the developed world and China to more frontier markets, which adds both opportunity and risk for these investments,” says Wayne Bishop, director of ethical fund management at King & Shaxson, which is owned by PhillipCapital. The fund house has managed ethical portfolios since 2002.

Of late, what has also been growing in interest is passive investing in sustainable investing products. According to data provider Morningstar, there are at least 28 smart beta products that use ESG criteria. In total, they have assets worth US$2.3 billion. “We expect to see attempts to bring more passive products to this market, with more indices being created to provide the basis for these products,” says Bishop.

For instance, European asset manager Candriam launched a number of ESG smart beta strategies last year. According to a survey by FTSE Russell, about 41% of global asset managers with smart beta strategies are using or plan to apply ESG filters. Locally, there is one sole exchange-traded fund with ESG strategy: CIMB S&P Ethical Asia Pacific Dividend EtF. It uses S&P Ethical Pan Asia Select Dividend Opportunities Index and has less than 5% exposure to alcohol, gaming, pork and tobacco. It has returned 20.7% in the last five years.

Still, observers say passive investing in this area may still be limited. “[Passive investing] will meet the need for part of this market, but as the sector is also at a higher risk from politics and technology disruption, one attraction of this space remains [the need] for a more active approach; therefore, there will be a rise in actively managed products, frontier investment products and private equity funds,” Bishop adds.

Guarding against ‘greenwashing’

While sustainable investing is expected to see greater interest from investors, particularly with the introduction of more products, the next few years are crucial for the sector not to slip into what observers term “greenwashing”. This means fund managers and businesses may advocate ESG or impact goals, but do not follow through with them or measure them.

The industry is particularly susceptible to this because there are no universal definitions of sustainable investing. Further, more than 50% of investors do not set impact targets for all their investments, according to a survey by Global Impact Investing Network (GIIN). Agencies such as MSCI and Sustainalytics that provide metrics of ESG performance take into account very different sets of criteria. In some of these indices, companies such as Nestlé and The Coca-Cola Co, which have been accused of damaging local environment, would make the top 10.

While investors are demanding greater ESG standards, lackluster leadership of governments in frontier markets can be a hurdle to the sector’s growth. “The Saudi killing of the journalist [Jamal Khashoggi] in full view of the world, and the mild reaction to it, is a shocking indictment against businesses and governments who continue to court the current rulers in Saudi Arabia. In view of governments’ unwillingness to take action in such cases, it is difficult for corporate to do so,” says Mobius, who is interested in raising corporate governance standards in companies in developing economies.

It is also incredibly expensive and resource-intensive to measure the long-term impact of sustainable investments. Take, for example, Credit Suisse’s Asia Impact Investment Fund, which invests in an Indonesian education company that provides affordable supplementary education to students. The education company has reached 10 million children. But to measure the exact impact on these children’s performance, the fund manager would have to invest in developing a range of metrics, which could include paying for control groups and publishing studies. That would virtually flatten its returns. So, the bank, like most asset managers handling sustainable products, relies on publicly available research. And, it acknowledges that the impact of its product may not be guaranteed.

Essentially, as sustainable investing sees greater interest from investors, there will be more investment products in this field, and these products are likely to be more sophisticated than simple exclusionary screening strategies. But with no firm definitions and measurement, it will become even harder for fund managers to hold companies accountable in producing measurable social and environmental impact.

To mitigate this, independent bodies are stepping in. GIIN and the International Finance Corp have created lists to better define and categorise impact investing to improve standards in a fast-growing multi-billion-dollar industry. In the next few years, the industry’s ability to measure the actual impact would serve as a barometer if sustainable investing numbers continue to get bigger.

This story appears in The Edge Singapore (Issue 863, week of Dec 31) which is on sale now. Subscribe here