2020: The year for institutional investors to get back to basics on ESG

Proactive investment in real assets is the solution to the climate change challenge

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If 2019 was the year institutional investors started taking the concept of ESG seriously, 2020 is the time for action. It’s undoubtedly positive that environmentally and socially responsible investments are now in vogue, but it’s proven to be difficult for institutions to quantify their impact. 

This year, investors need to ensure their ESG investments do what they say on the tin – with a clear and tangible link to the underlying asset level.

Many investors seeking to make impact investments are focusing on the defining issue of our time – mitigating climate change. It’s clear many are becoming concerned about the impact of their investments on the environment.

In a survey recently conducted by Octopus, 91% of institutional investors agreed that climate change was already having an impact, while 71% agreed this group can make a material difference in the fight against it. 

"If just a fraction of the overwhelming financial leverage that institutional investors possess were brought to bear to combat climate change, we could more than fulfil the Paris climate goals."

That matters, because concern about the effects of climate change are being felt, with 60% citing government and 49% citing clients as a source of pressure to clean up their acts.

The good news is that institutional investors hold significant power to affect environmental outcomes. PwC estimates global assets under management will reach $100 trillion in 2020, which is just under five times the nominal GDP of the United States. 

If just a fraction of the overwhelming financial leverage that institutional investors possess were brought to bear to combat climate change, we could more than fulfil the Paris climate goals. 

Yet those seeking to combat climate change through their investments face a series of challenges. A number of competing ESG metrics vie for widespread adoption, each measuring subtly different factors. This lack of standardisation allows financial products to be branded as ESG, when on closer inspection they have little real alignment with investors’ values. 

Some institutions, faced with the complexity of ethical investment, decide that divestment from clearly harmful assets, like oil and gas equities, is enough to satisfy climate targets. But it isn’t. 

Proactive investment in real assets is a far better answer to this difficult challenge. And real assets like renewable energy generation are a perfect example. 

For institutions, there couldn’t be a clearer case of an asset aligning with ESG goals. These investments fund the infrastructure that will wean the world off fossil fuels and contribute to the transition to carbon-neutral economies as a result. 

Investment in these types of ESG-aligned assets can balance institutions’ fiduciary responsibility to deliver stable, long-term returns for investors while improving the environmental credentials of portfolios. As demand for renewable energy grows across decarbonising economies, the sector will continue to expand.

The market is beginning to respond. Institutions will fire the starting gun on investing in renewables in 2020, with investors we surveyed planning to put over $300 billion into the sector across the next year. That figure rises to $643 billion across the next decade.

This represents a sizeable increase in the commitment of institutional investors to renewable energy infrastructure over current holdings. It should be welcomed.

Yet despite this trend, the funding challenge for renewables remains significant. In order to meet the Paris Agreement targets and limit global warming to well under 2°C by the end of the century, the International Renewable Energy Agency (IRENA) estimates that an investment of $27 trillion is needed in renewable energy by 2050. To reach this significant level of investment, strong action is required.  

If we want to effect real change, we need a much more wholesale approach. As asset managers, we must respond to the scale of the challenge, ensuring that we create a market that incentivises the flow of institutional money into climate-saving assets by providing flexible investment solutions for big institutions. And institutional investors must do more to ensure that funds allocated towards environmental causes are having a real impact.

It’s not often that institutional investors are afforded the chance to do well by doing good. But with regard to renewable energy infrastructure, the case could not be clearer.

The question is whether they will seize the opportunity in front of them in the next year, and in the next decade.

Chris Hulatt is co-founder of Octopus Group.