Being aware of the risks involved in sustainable investing can help you achieve impact.
When an investor has a clear idea of what sustainability means to them and has embedded it within their investment objectives, discussions about risk appetite are the natural next step.
Tolerance for risk has always dictated the majority of investment portfolios. However, the prevalence of greenwashing in the investments space is skewing investors’ perceptions of risk.
Greenwashing, when a company makes unsubstantiated claims that deceive investors into believing their operations or products are sustainable or more sustainable than they are, can make identifying whether a sustainable investment is what it claims a challenging process.
Being able to successfully manage and mitigate these risk elements in an investment strategy is essential. By understanding risk appetite and seeing through instances of greenwashing, investors can align their investment goals with the ability to deliver genuine impact.
“A truly impactful investment may involve giving up some liquidity,” says Stephen Metcalf, head of Sustainable Investing at RBC Wealth Management in the British Isles and Asia. But the client must determine: “Is that what [they] want? Does that match their goals?”
“Inevitably, there will be some trade-offs, both in terms of liquidity and potentially performance, particularly in the short-term,” says Metcalf. “Sustainable investments are susceptible to market fluctuations just like all investments, and there may be times where they underperform.”
“There are also certain times markets can value carbon-emitting investments,” says Andrew Maxwell, director, RBC Wealth Management in the British Isles. “In times of international conflict for example, oil prices can shoot higher or gas shortages may emerge. This can cause nations in need of energy to turn back to more traditional forms of energy production, such as coal fired power plants.”
“However, there are strong structural and societal trends behind energy transition,” he adds. “These long-term trends, supported by society’s momentum, political aspirations and increased regulation in favour of renewables, are still significant tailwinds for sustainability as an investment.”
That being said, it’s a delicate balance. There are many challenges facing advanced economies and sustainable investment markets, including greenwashing.
As sustainable finance practices and associated financial products have evolved, the issue of greenwashing has come to the fore.
Regulators are trying to crack down on greenwashing and are taking action against firms found to be misleading investors over the sustainability of their operations. That being said, “different understandings of what sustainability means and opaque sustainability metrics make it difficult to police,” says Metcalf. It is the wealth advisors’ job to conduct thorough due diligence to look at the reality behind sustainability claims and verify a firm’s sustainable commitments.
Electric vehicles (EVs) are a good example. On the surface, they are a sustainable investment, but “it’s not as clear-cut as ‘EVs are good, internal combustion engines are bad,’ because EVs still source scarce materials such as lithium, nickel and cobalt,” says Maxwell.
The emergence of companies able to recycle battery technology contributes to sustainable supply chains in the EV production process, so these investments can have a net-positive carbon impact. Therefore, to invest sustainably does not only mean backing renewable carmakers, but investing in sub-industry sectors, such as charging stations and EV infrastructure.
Investors must look beyond a product that claims “zero emissions” and understand the detail behind the production process.
Standardised and mandatory disclosures are an important step to safeguarding against greenwashing.
Conducting due diligence on investments is the best way to be sure an investment is sustainable. “Checking annual reports and documents that outline and track a company’s sustainability credentials through transparent reporting mechanisms are a must for any investment,” says Metcalf. Having access to this information can have a direct bearing on an investor’s portfolio and its performance.
It comes back to marrying a client’s ethical views with the ongoing analysis of a portfolio’s sustainability footprint – investors need to understand what their sustainable investment goals are and the implication of their decisions. This will help them reach a comfortable balance between avoiding harm, prioritising good business practices, and contributing to solutions.
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