The coronavirus pandemic and devastating forest fires has sparked an uptick in demand for Environmental, Social and Governance (ESG) investment strategies, which will accelerate the commercial adoption of more sustainable clean technologies.
The trend toward sustainable investing was already underway prior to the pandemic. According to a report from Morningstar, U.S. assets in sustainable index funds have quadrupled since 2017 and now account for 20% of the total. Analysts have provided a multitude of reasons, from the adoption of the UN’s Sustainable Development Goals by asset managers to the generational wealth transfer from baby boomers to millennial and Gen X.
What surprised many investors, however, is that ESG funds performed well relative to non-ESG funds during the market correction in mid-March. Fidelity reported that stocks with a better ESG rating still fell between February 19 and March 26, but outperformed the benchmark.
Perhaps because of that, demand for ESG investments hasn’t slowed and, in fact, may have accelerated this year due to Covid-19. According to data from ETFGI, ESG-themed ETFs raked in $38 billion in 2020 by the end of July, reaching $100 billion in assets for the first time.
It is certainly hard to ignore the link between climate change and infectious diseases, as outlined by the World Health Organization. But the other pivotal events that have taken place this year have also weighed on investors’ decisions, including the death of George Floyd and the subsequent Black Lives Matter movement, the economic fall-out from the pandemic, and the recent wildfires in California.
What ESG Means For Cleantech
As more investors seek to integrate ESG into their portfolios, we expect that demand for investment opportunities that fit within this framework will rise. This will likely increase access to capital – and critically, cheap capital – for businesses that can demonstrate they meet ESG criteria. We should therefore expect to see a boom in clean technologies simply because these projects will become easier to finance than more traditional forms of energy.
While cleantech often scores well on environmental factors, it’s important to consider the social and governance factors too. We should recognize that the availability of cleantech solutions, such as off-grid solar systems, which can now be installed practically anywhere on this planet. Increasing access to cheap, clean and reliable power is a catalyst to economic growth, educational attainment and better health. And when you combine that with digital access as well by powering telecommunications, those effects are magnified.
One ESG factor where cleantech companies fall short is on diversity among company directors and boards. For instance, according to the Solar Foundation, 88% of senior executives in the U.S. solar industry are White. For cleantech companies to attain better scores on governance, they need to recruit, train and mentor women, people of color and other underrepresented groups in the industry.
The risk of greenwashing
What will be critical is for investors to do their due diligence on ESG investments. A recent survey of Dutch pension funds found that six out of ten Dutch pensions agreed that some asset managers engage in greenwashing.
The risk that companies will talk up ESG factors in financial statements means that investors need to be conducting research into the credibility of corporations’ claims. But just because a project or company is cleantech doesn’t mean that it automatically meets ESG criteria.
As Joris Laseur, manager of engagement services and Ewa Klewar, senior associate, engagement services at Sustainalytics say, “For [cleantech] to maintain its social license-to-operate, however, it will also need to formulate answers to the environmental and social challenges throughout its value chains.”
They highlight that the process behind the products, as well as the whole product lifecycle, should be critiqued for sustainability. While external data from sources like Sustainalytics, can address this to some extent, the onus is on the investor to ensure that companies are doing what they claim to be doing.
Some of the issues we see facing cleantech companies in terms of meeting ESG criteria require greater consideration in the supply chain – for instance, sourcing lithium for solar power batteries, human rights and corruption issues among third-party manufacturers, and the waste from the production process. According to the Business & Human Rights Resource Centre, nearly nine out of 10 producers of minerals needed for the low-carbon transition have been linked to human rights abuse allegations over the past decade.
In addition, companies need to consider the social and environmental impact of their product once it’s in use – for instance, if a wind farm is detrimental to the surrounding ecology, if the interest payments on a residential solar installation are extortionate, or if the product has a limited use life that means it will end up in landfill after a couple of years.
The Proof Is In The Pudding
Investors are ultimately looking for profits and value creation. Responsible investors believe that companies with strong ESG metrics will generate higher risk-adjusted returns over the long-term. Cleantech is also generating better returns than legacy players in the same industry – Tesla TSLA has become the most valuable automobile manufacturer in the world.
We’re optimistic that the rise in ESG will help to increase investment and returns in cleantech. While this is bullish for the sector over the long-term, there are challenges that need to be addressed along the way.
First and foremost, a greater focus among CEOs and boards of cleantech companies on ESG factors – considering a slew of environmental, social and governance issues – will help make cleantech a responsible and profitable investment. Investors are becoming increasingly wary of ESG issues and expecting companies to address these factors in their financial statements, but it also requires a greater level of due diligence to ensure that these standards are being met. We are at a transition for ESG investing, where it is moving towards the “norm” – and that can only be a good thing, if it’s enacted properly.
To capitalize on the ESG movement, cleantech companies must themselves employ best practice ESG principles and deliver on higher risk adjusted returns. The trend and industry potential, and those that deliver on the promise will deliver significant rewards to their investors.
Source: Forbes – Business