Understanding links between science and sustainable investment

By Peter Michaelis, head of sustainable investment fund management, Liontrust

The future of sustainable investment has been questioned by a number of different parties recently. Yet, in contrast, the prospects for sustainable investment are arguably brighter than has been the case for some time.

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The criticism of sustainable investment follows a period of challenging performance for sustainable investment. Both equities and bonds in general delivered negative returns in 2022, the rise in inflation and interest rates have impacted growth stocks, and the dominance of the magnificent seven stocks have negatively affected funds with underweight positions in these companies on a relative basis.

Why sustainable investment?

The question often asked is ‘why is sustainable a good characteristic to look at?’. The classic definition of sustainable development is “development that meets the needs of the present without compromising the ability of future generations to meet their own needs”.

Unfortunately, a look at where society is today shows that we are operating very far from a sustainable level. Over the nearly 50 years since that definition of sustainable investment was first set out, each generation has left a more depleted environment for the next.

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The image below, produced by the Stockholm Resilience Centre, demonstrates the scale of the issue. This sets out nine planetary boundaries – critical aspects of our planet that need to be preserved for long run prosperity.

Nine planetary boundaries

Source: The 2023 update to the Planetary boundaries (licensed under CC BY-NC-ND 3.0). Credit: “Azote for Stockholm Resilience Centre, based on analysis in Richardson et al 2023. www.stockholmresilience.org/research/planetary-boundaries

Categories that go beyond the green are where we are having more of an impact than the planet can handle long term. The chart shows that six out of the nine categories are notably beyond what can be sustained, these include biodiversity and climate change.

Focusing in on climate change only emphasises the scale of the problem. Worldwide, carbon dioxide emissions have risen by close to 40% since our sustainable funds were set up in 2001. Given the global warming potential of these emissions, this is clearly far from sustainable.

Reasons to be optimistic

But there are grounds for optimism as a look at one of those planetary boundaries within the green – that of stratospheric ozone depletion – shows. Previously, the ozone hole was a huge problem but the control and reduction of ozone depleting chemicals under the Montreal Protocol is now on track to allow the ozone hole to recover in the coming decades.

Equally, a closer look at emissions data shows that in Europe there has been a 20% decline in absolute emissions since 2001. When it comes to capital expenditure on electricity generation the direction of travel has firmly changed, with around six times more being spent on renewables than on coal or gas. The international energy agency has also highlighted that solar photovoltaic energy is the cheapest electricity in human history.

The role of business

Behind the positive change are a number of factors, not least the interplay between science and understanding, government and society and business.

In particular, business has an essential role to play in innovating and refining solutions and extending the limits of what is possible. This emboldens governments to drive for further change. Over the years, this has led to safer roads, cleaner city air, clean drinking water, reduced childhood mortality and the acceleration that we have seen in renewable energy and in arresting the decline of the ozone hole. Investing in and supporting these businesses is where sustainable investing comes in.

Investment outcomes

While sustainable investment is still a small proportion of the overall market, it can have a disproportionate, catalytic effect.

There is an advantage in sustainable businesses that tends to be underappreciated by the market. Looking to the future, it is not hard to see that those businesses which are providing the solutions will potentially access vast growth opportunities. In many cases, the speed and scale of this growth is likely to be underestimated in the valuation of their shares.

This is where the opportunity lies – finding great companies and helping to solve challenges we face as a society and world, whose prospects are undervalued by the market. This comes as growth is likely to be scarce across the economy over the next few years.