Integrating the Sustainable Development Goals into Investment Portfolios

The 17 United Nations Sustainable Development Goals (SDGs) set aspirations and targets for economic development, social inclusion and environmental sustainability and they are applicable in the developed and developing world.

The 17 United Nations Sustainable Development Goals (SDGs) set aspirations and targets for economic development, social inclusion and environmental sustainability and they are applicable in the developed and developing world. The SDGs therefore provide an important framework for governments, companies and investors. Institutional investors should be particularly interested in the risks and opportunities the SDGs present to their existing holdings and how the SDGs will open up new investment opportunities.

Investors that prioritise companies with SDG aligned revenues could have an important signalling effect for companies.

Look at China for example, to see the strong political will and incentives to support clean and affordable energy (SDG7) as well as climate action (SDG13). Last year, Chinese clean energy investment hit $130bn, more than double the investment of the US – its nearest rival – and representing 40 per cent of global clean energy investment (BNEF 2018). Such opportunities are not just restricted to Asia. In the US, a transformation is also underway in the power generating sector and specifically in the distributed utility-scale solar and wind sectors.

These investment opportunities are timely since they are appearing when more global asset owners are establishing low-carbon commitments and seeking to increase their allocations that are aligned to specific SDGs. However, the available investment instruments to support specific SDGs are often limited to private equity or debt. This is typically true with SDG goals focused on basic needs such as ending poverty and hunger. Currently investments aligned to these goals are mostly served by microfinance institutions and development banks, but, these investment opportunities can lack sufficient size for large institutions.

This is perhaps why institutional investors are increasingly focusing their gaze on the listed equity and bond universe, which in certain sectors offers alignment to a number of SDGs. Data from MSCI provide investors with the tools to assess whether corporations in the listed equity universe are supporting one or a number of the SDGs. DWS analysed a range of benchmark equity indices to assess the degree to which the respective investment universe made a meaningful contribution, defined as deriving at least some revenues from SDG related products and services. The result was that in all the benchmark equity indices under investigation less than half of the underlying companies made a positive SDG contribution while around 70 per cent of all globally listed companies have a SDG revenue share of less than 10 per cent. When the SDG revenue hurdle is set to a quarter of sales around 500 corporations are captured, Figure 1. These corporations are typically concentrated in the alternative energy, energy efficiency and healthcare sectors. Meanwhile sectors under-represented include education (SDG4), affordable housing (SDG11) and life below water (SDG14).While a company may be reporting a large and increasing share of revenue streams making an SDG contribution, it may not comply with broader ESG quality and norm tests. To assess this risk we examined those companies where revenues supporting the SDGs were in excess of 25 per cent of their top lines and mapped those companies against Deutsche Asset Management’s proprietary ESG rating scores. These scores are derived from the external ESG data vendors MSCI, Oekom and Sustainalytics, as well as information on a company’s involvement in controversial sectors and compliance with norms covered by the UN Global Compact in the areas of human rights, labour, the environment and anti-corruption. This mapping of SDG revenues to ESG quality score reveals that approximately a quarter of companies with a SDG revenue stream in excess of 25 per cent fail a standard ESG quality test.

Turning to the sovereign bond market, funds that screen according to whether a country safeguards and enhances the political and civil rights of its citizens could enable investors into a more active role in promoting peaceful societies and building strong institutions, which aligns with SDG16 and supports progress on all Global Goals. Sovereign bond investors could therefore become more vocal in engaging Finance Ministries to support national SDG strategies.

Since women’s empowerment is both a pre-requisite and an outcome of achieving all of the SDGs, enabling women’s leadership is needed, at all levels of society, to support progress on every Global Goal (BSDC Jan 2017). Such a focus on gender equality is much broader than SDG5, which prioritises the need to end all forms of discrimination against women and girls and their equal rights to employment, health, education and all types of decision-making.

MSCI (Nov 2015) and other reports have found that improved gender diversity can improve financial performance of large companies. MSCI (April 2016) also found that 600 US companies with high gaps in pay between management and average workers were less profitable and had lower sales per employee. It is encouraging that more investors are asking companies to improve their internal diversity and reduce income inequality. However, such efforts should also focus on encouraging women leaders to influence their company’s sustainable business agenda.

Investors therefore have an important role to play in engaging companies to strengthen their SDG business strategies. The outcome of such engagement would be more companies that are seizing the $12 trillion investment opportunity of the SDGs with more revenue attributable to SDG related businesses. Investors allocating to equity and bond funds that prioritise companies with SDG aligned revenues could have an important signalling effect for companies to strengthen their SDG business strategies particularly in the areas of food and agriculture, cities, energy, materials, health as well as many other sectors.

Michael Lewis is Head of ESG Thematic Research at DWS, formerly Deutsche Asset Management.

This article was sponsored by DWS and RI editorial staff were not involved in the creation of this content

References
(BNEF 2018) Clean Energy Investment Trends, 2017 (January 2018). Bloomberg New Energy Finance
(BSDC Jan 2017) Business and Sustainable Development Commission (January 2017). Better Business, Better World
(MSCI 2015) MSCI ESG Research, November 2015. Women on Boards
(MSCI 2016) MSCI ESG Research, April 2016. Income inequality and the intra-corporate pay gap

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