What is Sustainable Investment?

Sustainable investment refers to a strategy that incorporates not only financial information in the investment decision-making process but also considers environmental, social, and governance factors. These three terms are abbreviated as “ESG”. The critical distinction here is this. Sustainable investment is not charity. It requires measuring the factors that impact the long-term resilience of a company from a wider perspective.

Sustainable investment is a critical matter across the world today. You ask why? Because if a company’s access to water becomes challenging, production would be interrupted. If the cost of a carbon-intensive model increases, margins would drop. A non-transparent management model would fall apart more quickly in moments of crisis. Sustainable investment’s claim is that long-term gains are for those who can read these signals early on.

Conventional analyses usually focus on questions, such as ‘Does this company make money, will it make money?’ Sustainable investment retains this question but adds new ones on top of it. Which costs might the origin of this profit be concealing? Would the company’s business model survive if regulations change? How do ESG risks, such as climate change, water stress, and access to raw material, transform this sector? Is management structure resilient against crises? Are there vulnerabilities in terms of human resources, supply, and reputation?

These questions look like ‘ethical’ questions, but most of them lead to financial outcomes. To put it differently, as we stated at the outset of the article,  accurate risk analysis lies at the heart of sustainable investment.

The purpose may be summarized in one sentence: More accurate pricing for long-term value. There are three ways to do this: Making invisible risks visible. Measuring the business model’s ability of adaptation to the future. Aiming at a more consistent portfolio resilience. Let's dive into the details.

ESG is the abbreviation for Environmental, Social, Governance. ESG does not consist of a single rating, rather it provides a framework. Some organizations score it, some funds turn it into a filter, and some integrate it into the financial model. The ratings of the same company can vary since ESG categories focused or weighed by rating institutions differ.

E: The environmental aspect: The environmental aspect is usually discussed from the ‘carbon’ perspective; however, the scope is much larger. Emissions and reduction plans, energy consumption, water consumption, waste management, interaction with nature, and climate risk management are among the categories monitored in this category.

S: The social aspect: The social aspect has a direct impact on the company’s daily operations and operational decisions. It includes categories such as occupational health and safety, fair working conditions, human rights in supply chain, product safety, and data security. The investment counterpart of this category is clear. Social risks that are not managed correctly lead to lawsuits and punitive action costs, carry the risk of interrupted production, and damage brand values.

G: The governance aspect: The governance aspect pertains to the question of “how is the company being managed?” along with what kind of structures and decision-making mechanisms are used to manage sustainability risks and opportunities. The structure of executive board, transparency, ethical rules, risk management, and incentive mechanisms are among the key elements of this category. If the governance is weak, all other commitments become more fragile. The rationale behind this is that we have come to understand that it is insufficient for companies to simply establish targets; what truly matters is their ability to meet these targets.

Many people believe that there exists only one method for sustainable investment. Whereas, sustainable investment does not consist of a single method, it is rather a wide framework with different approaches. So, how can we engage in sustainable investment?

Negative elimination

Negative elimination means choosing not to invest in some sectors. Most frequently encountered examples are areas such as tobacco, coal, and weapons sectors. The strength of this method is that it provides clarity for the stance of the investor. What you want and what you do not want becomes clear, decision-making process becomes simplified.

There is, however, a limitation to negative elimination. Some sectors are exactly at the center of transformation, and it may not always be the best idea to eliminate these completely. Sometimes the issue is not about ignoring that sector, but about being able to choose the companies with the right attitude towards transformation and to support this change.

Positive elimination

Positive elimination means to distinguish companies in the same sector and to invest in those with a better approach to implementation. The purpose here is not to find the “perfect” company. There is a more realistic objective: Among the companies operating under the same conditions, selecting those that manage risks better, demonstrate greater transparency, and exhibit a more robust management approach. This approach understands sustainability not as a claim, but rather as an indicator of management quality.

Thematic investment is an approach that is centered around particular transformation areas. Themes such as renewable energy, water technologies, energy efficiency, circular economy are examples of this. Thematic investment has the potential to seize significant trends. A good theme, however, does not always mean a fair price. This is why one must look into what the company really does.

Impact investment, on the other hand, refers to investments with a social or environmental impact objective. The main question here is this: What does this investment change in the world? Impact investment is powerful, but it is difficult to measure. This is the rationale behind the necessity for transparency and the enforcement of monitoring discipline.

As sustainable investment grows, everyone wants to be seen in this area. But not everyone ensures a real transformation. Greenwashing refers to practices that are promoted as sustainable despite having inadequate infrastructure. Please check out our blog post for further details on greenwashing.

We must ask the following questions to reduce the risk of greenwashing: Which year, which scope and which tools are used to set the target of net zero? If a fund says ‘ESG,’ is ESG a filter, an analysis, or a theme? If a report is too assertive, is there an independent verification?

It is possible to minimize the risk of greenwashing by posing these questions, analyzing data, and thinking critically. The way to do that passes from seeking ‘measurable claims’ rather than beautiful narratives.

The rise of sustainable investment is not a trend. As we stated at the beginning of the article, the main reason is the changing risk map. Today, there is a much wider range of factors that influence companies compared to the old days.

Climate crisis is the clearest case of this change. It influences companies in two ways. The first one is the physical risk. In other words, interruption of production and supply chain operations are due to events such as floods, fires, drought, and extreme heat. The second is the transitional risk. Increasing costs for carbon-intensive business models, new regulations coming into effect, and the necessity of transitioning to a low-carbon economy.

Sustainable investment helps us to see these risks from early on. Not only risks, but also opportunities become more visible. Big changes such as energy efficiency and energy transformation create new sectors and new value chains. This indicates great potential for investors who have positioned themselves accurately at the appropriate moment.

It is not necessary to have complete knowledge beforehand to begin engaging in sustainable investment. What is important is to focus on understanding the content instead of merely considering the label. Many investors start off with sustainable investment funds. This is a practical way. However, it is not sufficient for a fund to have ESG in its name. What is needed is to understand which method is used by the fund. What does it exclude, what does it reward, where does it position ESG in its analysis... All of these should be considered.

For the ones who want to choose companies one by one instead of funds, the heart of the matter is this: Is there commitment, a plan, an implementation? To put it in different terms, are the objectives of the company merely articulated, or are they founded on an actual transformation program that is being implemented? The same question applies for tools such as green bonds. Where does the money go, how is it reported, is there an independent verification process? These questions are invaluable because the claim of sustainability weakens if there is no transparency.

If you want to make a sustainable investment, you should first identify your priority. What is more critical for you: climate, social impact, or governance? Then, you should clarify the term. This approach is usually meaningful in the long-term. After this, choose a method. Is it negative elimination, ESG integration, thematic investment? Finally, you should remember to monitor discipline. Companies change. Risks change. Portfolio needs to be updated. The simplest and most correct way to start is to build a small portion of the portfolio in this manner and improve it over time.

Sustainable investment is not only a value-based approach. It is also part of a sound investment. The reason for this is the changing definition of risk. Categories such as climate, regulations, supply chain, reputation, and governance create direct impacts on the future of companies. Therefore, the essence of sustainable investment is noticeably clear: Thinking in longer-terms. Asking better questions. Reading the method, not the label.

You do not need to make big moves to start. Identify your own priorities. Create a simple basket. Monitor continuously. And you will start to make better decisions in time.