Sustainable investment is the selection of assets that contribute in some way to a sustainable economy. It is a term broadly used for the consideration of typical environmental, social and governance (ESG) issues and includes ESG integration, which considers how ESG issues impact a security’s risk and return profile. Since the last decade, ESG analysis has become an increasingly important part of the investment process. According to Morningstar, an independent research firm, demand to invest in funds that incorporate elements of ESG analysis jumped in 2020, driving assets under management to nearly USD1.7 trillion. This figure further climbed to ~USD3.9 trillion at the end of September 2021.
Source: Morningstar Direct
The surge in ESG assets amid COVID-19 is a result of many factors. The pandemic has strengthened the interconnectedness of sustainability and the financial system—from climate change to social unrest. While it is challenging to assign a monetary value to a sustainability factor, sustainability-minded investors all share a similar and simple belief: countries and companies with sustainability at its core will not only survive but also thrive in the long run.
The Ecosystem of Sustainable Investment
Governments, international organizations, corporates, asset managers and various private-sector market participants are playing important roles in promoting the concept and practice of sustainable investment. This ecosystem, as illustrated in the diagram below, is contributing to the growth and institutionalization of ESG investment approaches and methodologies.
Source: AIIB
Sustainable Investment Strategies
Depending on the comprehensiveness through which the investor seeks to utilize the ESG framework, there are seven core approaches to sustainable investment as shown in the diagram below.
Source: AIIB
ESG integration is now the most commonly deployed strategy by investors. Such integration would require ESG consideration to become a DNA of a firm’s culture and an integrated part of investment processes, as ESG factors are assessed during the asset allocation, portfolio construction, risk management and scenario analyses.
It is interesting to see how investors switched among those approaches in the past few years as investors continuously explore the approaches that best suit their investment mandates, as illustrated below.
Source: Global Sustainable Investment Review 2020, Global Sustainable Investment Alliance
Different sustainable investment strategies have experienced different growth trajectories. Negative/exclusionary screening was adopted by most investors during initial times as this strategy is straightforward with the least amount of complexity. As capital markets start to see more transparency in disclosure and improvement in sustainability assessment capacity, ESG integration has replaced negative/exclusionary screening to become the most widely used sustainable investment strategy among investors.
These strategies are not mutually exclusive and portfolios could simultaneously apply more than one. For instance, in the Asian Infrastructure Investment Bank (AIIB) Asia ESG Enhanced Credit Managed Portfolio, abrdn who is acting as the investment manager, has adopted a blended approach in the pre-investment and post-investment stages.
Sustainable Investment in Asia
Europe and North America are the two traditional leaders in sustainable capital flows. However, more and more investors are looking to Asia for setting a foundation for future growth. The growing dominance by the regional economy and the green emphasis of the stimulus packages at the time of COVID-19 are some of the reasons behind this.
Source: Sustainable Debt Market Summary H1 2021, Climate Bonds Initiative
It is clear that the awareness of ESG issues and the concept of sustainable investment is widely spread across the Asian financial sector. However, the practice is still in its early days. Market participants are interested, but many have not yet had an opportunity to develop sophisticated models which could reflect features of sustainability in their investment practice.
Some Asian investors have called for the creation of a distinctive Asian approach to sustainable investment. They argue that simply adopting or implementing a Western approach that does not incorporate the Asian cultural or value system in the process may not be effective. So far, however, there is no clear consensus in market practice. The potential for a distinct Asian approach to sustainable investment will start to emerge as more products are launched in Asia that take account of ESG criteria, including indexes, funds, and labelled bonds.
Promoting Sustainable Capital Markets in Asia: The AIIB Way
AIIB is a multilateral development bank financing infrastructure with sustainability at its core. Recognizing the effort that the Bank put into driving forward the ESG agenda, AIIB was unanimously chosen to win the IJGlobal ESG Awards 2021 in the category “Public Sector / Multilateral Award”.
Launched in 2019, the AIIB Sustainable Capital Markets Initiative (SCMI) aims to drive green and sustainable capital markets across Asia. In September 2021, the initiative won the Environmental Finance IMPACT Awards 2021 in the category “Impact initiative of the year - Asia.”
The SCMI consists of four pillars and has also seen AIIB develop its ESG Framework and Climate Change Investment Framework to catalyze investing strategies and act as an agent of positive impact to improve ESG standards and build capacity around sustainable investment with various market participants.
The four pillars are: AIIB’s capital markets portfolios, including the AIIB Asia ESG Enhanced Credit Managed Portfolio, the Asia Climate Bond Portfolio and the Asia Infrastructure Securitization Program; ESG research on emerging issues and sustainability trends; promoting and expanding ESG rating coverage of corporate issuers for better transparency and disclosure; and capacity building of all market participants to deepen the debt capital markets in emerging Asia and improve the understanding of sustainability through knowledge sharing and industry engagement.
“ESG considerations are not new. Under the AIIB SCMI, we are referring to a systematic approach rather than a cursory inclusion of one or more ESG indicators. It takes time to see the influence on financial performance and therefore ESG-minded investors should aim for positive externalities and long-term value creation,” said Dong-ik Lee, Director General of Banking Department Region 1 at AIIB.
AIIB looks to use its own investment portfolios to build evidence-based proofs of concept and to act as a test bed for future sustainable investments. Through these demonstrations, it aims to promote investor understanding of established ESG concepts.
Almost two years since its launch, the Asia ESG Enhanced Credit Managed Portfolio has seen positive performance, both in terms of returns as well as sustainability indicators. This project seeks to entrench ESG principles into Asia’s corporate bond market, which is critical to helping fund the region’s infrastructure development. The two major approaches to achieve impact are ESG integration and ESG engagement with issuers. The project has also received wide industry recognition so far: It won the Environmental Finance Bond Awards 2021 in the category “Investor of the year (fund)” as well as the Environmental Finance Sustainable Investment Awards 2021 in the category “ESG investment initiative of the year, fixed income.”
Looking Forward
The COVID-19 pandemic has exposed fault lines, vulnerabilities and structural weaknesses in emerging and advanced economies with the recovery now expected to be long, uneven, and uncertain. However, when the world appears upside down, there are opportunities to imagine, plan and build for a more resilient and sustainable future. Five years into its operations, AIIB will continue to seek new investment opportunities to set the world on a greener, more sustainable, and inclusive path.
