Decoded: abrdn examines the world of sustainable investing

As the COP 29 climate conference brings sustainability into the spotlight once again, investors may wish to familiarise themselves with related concepts and terminologies to better understand how they apply to investment strategies.

What is sustainable investing?

Sustainable investing refers to investment strategies that consider ESG factors while seeking to deliver financial outcomes.

While the term 'sustainability' refers to the broad concept of meeting today's investment needs without compromising the ability of future generations to do the same, ESG typically refers to the varied approaches organisations and investors may adopt to assess, measure and communicate the environmental, social and governance aspects of their activities.

• Environmental

  Environmental considerations may include climate change factors, such as carbon emissions or other environmental challenges, including pollution and biodiversity.
• Social

  Social considerations can refer to a range of issues affecting an organisation's own workforce and wider society, including pay and opportunities, as well as human rights.
• Governance

  Governance refers to the way in which an organisation is run. Corporate governance assessments may consider transparency, decision-making structures, culture and board issues.

A key concept within sustainable investing is 'double materiality'. This differentiates between impact materiality, which refers to an investment's impact on the planet and society, and financial materiality, which is the impact of the planet and society on an investment's financial potential. It is important for investors to be clear on which aspect of materiality (or both) is driving their investment decision-making within a particular strategy.

"Sustainable investors argue that organisations with sustainability practices can succeed in a world where environmental and social issues are likely to become increasingly challenging, including from a financial perspective."

Dan Grandage, Chief Sustainability Officer, Investments

Types of sustainable investing

There are various types of sustainable investment approaches, which the Global Sustainable Investment Alliance (GSIA), Chartered Financial Analyst (CFA) Institute and Principles for Responsible Investment (PRI) jointly categorise as follows:

• Screening

  Screening involves setting criteria to determine whether a financial security can be held within an investment portfolio. Many funds exclude assets from companies involved in certain activities, such as the production of tobacco or cluster munitions.
• ESG integration

  ESG integration incorporates ESG analysis into the investment process. This allows investors to identify and directly assess the potential effects of ESG factors on financial returns.
• Thematic

  Thematic strategies invest with a view to addressing specific sustainability challenges, such as climate, biodiversity or equality.
• Stewardship

  Stewardship involves investors actively engaging with organisations, including exercising their rights as shareholders or debtholders, to protect and enhance the long-term value of an investment.
• Impact

  Impact investment strategies include specific aims to generate positive, measurable social and/or environmental impacts alongside financial returns.

Many sustainable investment strategies will consider not only whether an organisation is meeting its sustainability objectives today, but whether it has clear, achievable plans to do so within a stated time frame. For instance, a company may set targets to decarbonise in line with the goals set out in the Paris climate accord.

Investors can access sustainable investment strategies across the full range of asset classes, from equities to fixed income, multi-asset and private assets, such as real estate. Sustainability strategies may be actively managed through a discretionary approach or, increasingly, through quantitative approaches that tilt portfolio allocations according to ESG criteria.

Promoting sustainability & addressing greenwashing concerns

Sustainable investing has attracted investors who aim to achieve more than just financial outcomes. At the same time, there have been growing concerns among investors, regulators and industry bodies alike about 'greenwashing', which may involve an investment manager exaggerating or misleading stakeholders about the extent to which its investments or operations are sustainable. This has led to the introduction of guidance and regulations that aim to clarify standards for disclosure, reporting and the promotion of sustainability within the finance industry.

Some of these include:

• PRI

  The United Nations- (UN-) supported Principles for Responsible Investment (PRI) offer globally recognised guidance on responsible investing. Its signatories are regularly assessed on their ESG performance based on the PRI's methodology and reporting structure.
• SDGs

  The UN's 17 Sustainable Development Goals (SDGs) provide a blueprint for its member states to achieve peace and prosperity for people and the planet. A fund manager may, for instance, map its investment strategy to the 17 goals to demonstrate how it is helping to contribute towards them.
• SFDR

  Sustainable Finance Disclosure Regulation (SFDR) is the EU's comprehensive legislative framework, which imposes mandatory ESG disclosure obligations on fund managers. Funds are described under Articles 6, 8 and 9, which indicate the level of sustainability-related disclosure provided for the investment product.
• SDR

  Sustainability Disclosure Requirements (SDR) refer to the UK's new regulatory framework. In layman's terms, this could be considered the UK's response to SFDR, but there are key differences. Notably, SDR includes four explicit product labels that define sustainable investing approaches.
• TCFD

  The Financial Stability Board's Task Force on Climate-related Financial Disclosures (TCFD) is designed to promote effective climate-related disclosures. Investors can use this information to assess an investment's climate-related risks and opportunities.
• TNFD

  The Taskforce on Nature-related Financial Disclosures (TNFD) is a more recent development that has similar objectives to the TCFD, but with regards to nature-related considerations, such as biodiversity.

Growth of sustainable investing

Global ESG assets surpassed $30tn in 2022 and are on track to surpass $40tn by 2030 - over 25% of a projected $140tn in assets under management, according to a January 2024 ESG report from Bloomberg Intelligence (BI)¹.

BI's forecasts show that Europe is set to remain the largest market, with over $18tn in ESG assets in 2030, preserving its 45% global share. While there is increased uncertainty around the near-term trajectory of sustainable asset allocation following Donald Trump's re-election as US president, we believe the path will become clearer as 2025 progresses.

Which sustainability approach is right for you?

Sustainable investing is an extensive area that encompasses a large array of investment strategies, ESG considerations, regulatory frameworks and related concepts. By equipping themselves with more knowledge, investors can better evaluate which approaches can best suit their own personal preferences, with a view to achieving both financial and sustainability objectives.