A Few Thoughts On The Ethical Investment Boom

In a recent newsletter we featured a great FT piece on the The Ethical Investment Boom.  It got me thinking. In debt capital markets, ethical investing is synonymous with one thing: green bonds. But the ethical arena is much bigger, more diverse and complex than one product. It’s worth pausing for a moment to reflect on how far we’ve come in this space and what is needed to drive the next phase of growth.

This week sees the annual IMF meetings in DC, where all the major SSA borrowers will be convening and environmental, social and governance (ESG) is sure to be a prominent topic on the agenda – particularly green bonds. As I kill time in Heathrow awaiting my flight, I thought I’d share my thoughts on this burgeoning sector.

Everyone knows what ethical investment entails. To date, the equity investment process on the whole has been about eliminating unethical companies, rather than identifying companies that have quintessentially ethical operational practices. Investors look to exclude companies that exploit individuals and communities and disregard the welfare of employees. This doesn’t just mean tobacco producers and weapons manufacturers – the screening process can also include businesses with opaque disclosure standards and conflicts of interests.

In debt capital markets, ethical investment tends to mean green bonds. We’ve written about the complexities of this subject here. Green bonds are a huge growth area for dealers and issuers and the market is expected to reach an annual value of over $200 billion in 2017, up from $10 billion in 2013. Supranationals have led the charge with issuance and investor demand grows.

But how big is ethical investment? Measuring the total value is fraught with difficulties. The Global Sustainable Investment Alliance estimates that levels reached $10.4 trillion in 2016, up 38% from 2014. But its definition of ethical investment – as the explicit inclusion of ESG factors into financial analysis – feels somewhat vague.

Similarly, it’s hard to gauge the sector’s performance versus the broader market. The FT article presents numerous charts that suggests that funds observing environmental, ESG standards tend to outperform those that don’t by a significant margin. But a glance at the comments at the foot of the article highlight the shortfalls of this argument.

Clearly, the market is growing as investors seek to access the opportunities created by a new wave of cost-effective and scalable technologies, insulate themselves against reputational damage, benefit from broader supply-demand dynamics created by institutional benchmarking and of course, the stuttering of the old commodities supercycle. Government subsidies included in the 2015 UN Paris climate accord have aided growth of the sector, too.

A more cynical perspective: the ethical investment boom is a product of vague and malleable semantics, with investors exploiting ambiguities to profit from the performance of companies that are not truly implementing ethical practices. We touched upon this previously, citing the phenomenon of “greenwashing” whereby unsuitable projects are financed through green bonds.

Let’s face it, there’s a lack of global consensus on what constitutes ethical standards across markets – semantically, but also at the foundational level of private and public operational practice. Investment decisions in this space still feel subjective and discretionary.

Major obstacles – the biggest of which is fragmentation of standards – inhibit the development of the market. Despite these hurdles, the future is bright. Clear guidelines are taking shape, and high profile signatories are slowly putting their names to the UN Principles for Responsible Investment, which has survived for over a decade.

The bond market is clearly an instrumental part of this movement, representing significant capital flows and deep-rooted institutional, corporate and governmental partnerships that extend across borders. Debt capital markets have lead the charge in the ethical investment sector. In order to keep it that way it’s time for a full and frank discussion about what it means to operate and invest in an ethical way.