By Christian Nolting, Global Chief Investment Officer and Head of Wealth Discretionary, Deutsche Bank Wealth Management
Developments in the investment world continue to evolve rapidly. Environmental, social and governance (ESG) criteria have found their way into the investment mainstream. One estimate in mid-2020 put the value of assets under management (AUM) applying ESG principles at more than US$40 trillion.
Rapid recent growth in ESG investment has prompted some understandable questioning, including around the likely sustainability of this upward trend. Will investors keep pushing into ESG investments, or will there eventually be some loss of enthusiasm? We would argue that multiple factors will continue to underpin the case for ESG and would like to highlight three of these factors here.
The first factor discussed below is the increased levels of ESG interest in geographic areas such as Asia.
The second factor is the deepening (figuratively and literally) of ESG investment to include such areas as the “blue economy” and new investment vehicles.
The third factor relates to the impact of COVID-19 on government finances; with these under increasing pressure due to the coronavirus pandemic, private ESG investment may help to counteract shortfalls in areas previously funded by governments or multilateral institutions.
Broadening geographic appeal
The application of sustainable investment principles and investor interest in ESG investment has varied around the world in recent years. Europe has been seen as a leader, followed by the United States. Now interest in ESG is broadening out, not just within individual markets but across geographies. Interest in ESG investment in Asia, for example, has been growing fast, confounding old “received wisdom” about why ESG would be less applicable in the region. We should remember that ESG investment has, of course, overcome similar arguments in developed markets such as Europe and America over the last few decades.
The difficulties in applying ESG principles will, of course, still vary between regions. It is probably more difficult to apply ESG principles in regions that are growing very fast (as many Asian economies have been, at least until recently). The very diversity of large geographic regions can also conceal significant ESG progress in individual countries. But where there are difficulties, there are also positive drivers. Many emerging economies, for example, have a growing middle class that may have an increasingly positive attitude towards sustainable investing. The obvious dangers that environmental factors pose may also be very visible to such populations. Rising sea levels increasingly concern not only small islands but also some highly developed economies. Another advantage for many Asian economies is the region’s strong technology base, which could help implement much ESG investment (and also provide data to assess its impacts).
Green is also blue.
The second argument for ESG investment to grow further in the future is the broadening of the investment universe to address the growing interest in new areas such as the “blue economy” and include new financial instruments.
A growing realisation of the importance of biodiversity and nature’s contribution to the global economy has been one factor behind the greater interest in the “blue economy” (defined as economic activity directly or indirectly connected to oceans, coastal areas, lakes and rivers). According to one estimate, so-called “ecosystem services” are worth US$125-140 trillion each year—more than 1.5 times the value of conventionally measured global GDP.
Financial markets have not fully caught up with this increased interest, although there are many areas of progress. For example, market awareness of “green bonds” has continued to grow, perhaps helped by a growing investor acceptance that environmentally beneficial investments need not deliver worse returns than conventional approaches. In 2019, according to the Climate Bond Initiative1, the total issuance volume for green bonds was $257 billion (a new world record), but this is still a small share of the overall bond market. The sub-sector of “blue” (or “blue ocean”) finance is even smaller, albeit with some interesting initiatives (such as the Republic of Seychelles issuing the first “blue bond” and recent fundraising by the Nordic Investment Bank for wastewater treatment, pollution and climate-change adaptation). So, both above and below the water, there seems to be plenty of room for growth in both “green” and “blue” investment.
The funding balance will change.
Another argument for further growth in ESG investor interest is that the balance of funding for much “green” and “blue” investment will change, with private-sector funding increasingly complementing that from official national or multilateral sources. This trend will probably be accelerated by the world’s continuing struggle with the coronavirus, which has put individual government budgets (and thus, ultimately, multilateral funding) under greater pressure. The hope is that private-sector funding for environmental, social and governance projects will step in to fill the gap. This shift in balance could have important implications for certain ESG-related areas; for example, it is estimated that about 80 percent of biodiversity finance is currently delivered through government or multilateral-linked investments that rely on non-market mechanisms.
There is also a growing desire to boost “green investment” as part of the recovery from the coronavirus, particularly in Europe. Ursula von der Leyen, the European Commission’s (EC’s) president, has set a target of using green bonds for 30 percent of the up to €750 billion that will be borrowed under the NextGenerationEU2 recovery fund. Emerging-market initiatives have also continued, with new plans from Chinese government agencies for green investment and finance unveiled in October 2020. All of this may also argue for a further increase in ESG investment in the coming years.
Of course, the ESG-investment path will not be a completely smooth one; debate will, quite rightly, continue around its performance measurements versus those of other investments, the most appropriate financial instruments, regulation and so on. But the combination of these three factors—broader geographic interest, new investment areas and investment vehicles, and growing need for private-sector finance—seems likely to keep interest in ESG investment on an upward trend.
Finally, but most importantly, we should note the growing role of technology in all three factors touched on above. Technology will help us to boost our knowledge at multiple levels—from the profound (how exactly ecosystems operate) to the more “profane” (performance contributors to ESG investment). It will help us to reimagine existing industries as well as invent new ones to better suit the long-term needs of the world’s populations—and much else besides. Altogether, we really are living in “environmental times”.
1Climate Bonds Initiative: Green Bond Highlights 2019: Behind the Headline Numbers: Climate Bonds Market Analysis of a record year, February 2020
2European Commission: The pillars of Next Generation EU, July 2020