Introduction to Sustainable Investing

This document is issued by Isio Services Limited which is authorised and regulated by the Financial Conduct Authority (FCA), Firm Registration Number: 922376. This document is intended solely for distribution to Professional Clients for the purposes of the FCA's Handbook of Rules and Guidance and should not be relied upon by any other person.

• Climate risks include physical risks from extreme weather events and transitional risks from the shift to a low-carbon economy.
• Climate finance is booming, reaching $1.3 trillion in 2022, but there's a gap to meet Paris Agreement goals.
• Isio helps clients navigate the complex world of sustainable investment and offers expertise in integrating sustainability themes into investment strategies.

There is a wide range of sustainability themes that investors are increasingly focused on within risk-return frameworks. Within this article, we focus on three particular sustainability themes; Climate change, Nature exploitations and Rising global inequalities. At Isio, we do not view these themes in isolation but as inextricably linked. In our experience, we feel there is a tendency for investors to have a ‘climate tunnel vision’ focusing largely on emissions reduction. However, we are now seeing investors consider a wider range of sustainability factors as part of a more holistic risk management approach.

Climate change

We have seen climate change rise to the top of everyone’s agendas, from investors to governments alike. Scientific researchers have issued warnings of the planet warming to unstainable levels. We believe this will result in significant environmental and financial impacts. For example, our proprietary climate model demonstrates that climate risk could cost over 50% of GDP this century and hence is a material financial risk for investors to consider. 

Climate risks have become an important factor in investment decisions and analysis given the potential impacts on investment markets. 

The key risks to consider are: 

• Physical – those which arise from acute and extreme weather events and chronic shifts in weather patterns. These physical risks are hard to price into investment markets, potentially exposing stock markets to price shocks, with knock-on impacts that may also impact wider asset classes. 
• Transitional – driven by the transition to a low-carbon economy. Transition costs for polluters may be significant over the near to mid-term (over the next roughly 30 years), which may impact return potential across asset classes and certain sectors. 

The climate market is growing exponentially, with climate finance flows reaching around $1.3 trillion in 2022, nearly double since 2020. There however remains a finance gap should countries seek to keep the hope of meeting the Paris Agreement alive, to keep global temperature rise to well below 2 degrees Celsius. 

The low carbon transition may offer various climate-related opportunities for investors, and it is important to identify those assets that are best placed to benefit from decarbonisation efforts. For example, low-carbon transport and renewable infrastructure will likely benefit from increased government support and incentives, to support carbon emissions targets. Fund managers identifying these opportunities can seek to generate superior returns and manage climate transition risk. 

Carbon markets are also a growing area, with the aim to place a price on carbon to encourage the highest emitters to reduce their emissions. We believe investors could further explore opportunities within carbon credits and carbon price hedging as return diversifiers as well as for portfolio risk management. 

Nature exploitations 

A nature-positive future consists of living harmoniously with nature in a way that enriches biodiversity, whilst alleviating global risks such as climate change. 

Certain ecosystems are essential to life on our planet. With half of global GDP – around $44 trillion – dependent on nature and its services, it is important to account for nature risk within portfolios and overall risk management frameworks. As with climate risk, there is a physical cost of a nature breakdown; for example, pollination species are vital for crop production and provide around $200 billion, in pollination benefits for the agriculture sector. 

We believe investee company supply chains and revenues are becoming increasingly sensitive to nature degradation. Those companies that are able to adapt, as well as support nature restoration, are likely to fair better in the longer term. 

In our experience, investors are increasingly seeking nature-based investment opportunities, especially given its ability to create win-wins for delivering nature and climate objectives within portfolios. Nature-based solutions focus on actions designed to protect, manage, and restore ecosystems that provide environmental and financial benefits. These products may generate carbon credits, an area in which we see increasing investor interest in seeking diversified returns. 

The private sector can play an important role in bridging the finance gap to achieve global nature targets. We believe there are nature opportunities across asset classes, from real asset investments in forests or agriculture, to green corporate or sovereign bond issues, sustainability performance-linked loans, or equity opportunities in listed or private markets.

Rising global inequalities 

Climate and environmental issues have often dominated investor agendas leading to a tendency for a ‘climate tunnel vision’. We have therefore seen less progress in investors seeking to tackle various social concerns, covering such issues as human rights violations, modern slavery, and access to clean water and healthcare. 

Recent geopolitical events such as the Ukraine-Russia conflict and the cost-of-living crisis have contributed to short-term market volatility. This emphasises the importance of considering social factors as part of a holistic approach to downside risk management. Identifying and managing such risks will typically be captured as part of a broader sustainable or impact strategy rather than as a dedicated social product. 

Social factors can be difficult to define. However, the UN’s Sustainable Development Goals (SDGs) provide a starting point for identifying social focus areas with improving inequality being a key driver for many of the goals, including access to clean water, education and healthcare. According to a recent United Nations Trade & Development (UNCTAD) report, there is a finance gap of around $4 trillion in delivering the SDGs, suggesting that private markets could play a significant role. 

We know that a changing climate will exacerbate global inequalities and that the transition to a lower-carbon economy requires a social focus. The just transition aims to ensure that the transition to a greener economy is fair and inclusive, for example, the re-skilling of high-carbon workers to low-carbon jobs. 

There are an increasing number of products with a focus on driving action on social issues, from real asset investments in social housing, to social corporate bond issues, or equity opportunities in listed or private markets. 

Investor action

Environmental and social factors are interlinked, both on a financial and humanitarian scale. The sustainable investing product landscape is diverse which means investors can often find an investment product which meets their priorities and objectives. These investment decisions should be grounded in financial drivers as well as to drive positive impact across sustainability themes. At Isio, we can support our clients on their sustainability journey, whether they wish to target multiple sustainability themes or have a specific area of focus. There is a myriad of institutional providers in these areas and we have firsthand experience of researching the participants, forming our view on which approaches best meet an investor’s objectives. Beyond measuring the level of sustainability integration within investors’ portfolios, we can advise and design bespoke investment strategies that aim to meet all sustainability priorities in an efficient and diverse manner. 

Our Sustainable Investment team have a wide range of experience advising significant institutions across asset classes. We apply this shared learning to the objectives of our Private Capital clients, where our insight can help to identify which managers meaningfully meet their sustainability goals as well as their financial return and risk targets. In a financial world awash with jargon, mixed metrics, data points, truisms and technical content, understanding the wider context, positioning and capabilities of providers is a real challenge. Aligning investor objectives is therefore a significant research exercise that requires a trusted partner. Independent and entirely client-aligned, Isio looks forward to being your guide on the sustainable impact journey. 

We will shortly publish a further article which will outline how we can best support clients to implement a sustainable strategy in practice and the investment case for doing so.

Contact Rob Agnew, Partner, isio Private Capital rob.agnew@isio.com for more information.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.