Future returns depend on sustainable investment

Our economy needs to be rewired to thrive within environmental limits and their social consequences, writes Penny Shepherd

The dynamics around wealth creation are changing and sustainable investment is set to become fundamental to good returns as the world faces up to the challenge of moving to a resilient and resource-efficient society.

Today, we face environmental limits and their social consequences. For example, international agencies predict that by 2030 the world will need around 50 per cent more food and energy, together with 30 per cent more fresh water, at the same time as we seek to mitigate and adapt to climate change.

We see the impact of extreme inequality in a world of near instant communications and a shift to new ways to manage public spending within the developed economies.

These forces introduce huge demand for innovation and new business models. New ways to seek profits are emerging while changing regulation and consumer demand are altering the returns from some traditional industries. This is why many thoughtful investment professionals think sustainable investment approaches offer some of tomorrow’s best opportunities for profit, growth and jobs.

Private investors have seen the benefits for some years, particularly in thematic investments, where funds invest in companies using social and environmental themes like water, agriculture or energy efficiency, which focus on areas where social or political pressures are creating strong business opportunities for the future.

The challenge is comparable to the industrial revolution or to rebuilding after a major war

Institutional investors are recognising the challenge. In a 2011 report commissioned by 14 global investors, Mercer, the investment consultant, highlighted the risks of climate change to investment portfolios and recommended that investors could benefit from increased allocation to “climate-sensitive assets” such as infrastructure, property, sustainable equities, agricultural land and timberland to help to mitigate these risks. Earlier this month, Mercer released new research showing that these investors were changing their asset allocation strategies and increasing their engagement with companies in response to the report findings.

Here in the UK, we need to “rewire” the economy for success within environmental limits. The challenge is comparable to the Industrial Revolution or to rebuilding after a major war. We must build new sources of energy and manage and distribute it more effectively. Similarly, we need to devise new ways of reusing natural resources in place of virgin materials. To achieve this, some £370 billion of additional investment is needed by 2025, according to a 2010 report from management consultants Ernst & Young.

The UK government has responded by creating the Green Investment Bank, the world’s first development bank for the low carbon economy. When it starts to invest later this year, it should speed up private sector investment into UK green infrastructure so that our economy is fit for the future.

With similar investment demands around the world, civil society projects like the Climate Bonds Initiative are already setting global environmental standards for the new investment vehicles that are expected to result.

Retrofitting the UK’s housing stock to dramatically increase its energy efficiency is another huge challenge. The Green Deal mechanism will enable householders to pay for this through their energy bill savings rather than making an upfront payment. This introduces a significant need for capital to meet the initial cost. Before Christmas, the government recognised the importance of this area by confirming that the Green Investment Bank would also facilitate investment into the Green Deal.

Other investment areas such as forestry funds are still developing. In time, these are expected to profit from providing a wide range of ecosystem services.

Of course, the opportunities are not only environmental. We are seeing the early stages of a revolution in public services comparable to the privatisation of the 1980s. Today, the focus is on new non-profit organisations at arm’s length from government that are paid for the social outcomes they achieve rather than the services they deliver. Investment is needed to pay for the initial service delivery and share the risk and return of this results-oriented approach. Social impact bonds are one mechanism being used to fund early pilots in areas like reducing reoffending and supporting families with complex needs.

Whether you see tackling environmental and social challenges as a business opportunity or a social imperative, or both, now is an exciting time to consider sustainable investment.