One of the most notable investment trends in the last decade is the rise of Environmental-Social-Governance (ESG) Investment. Also referred to as “Sustainable Investment” and “Socially Responsible Investment” (SRI) among other labels, ESG Investment strategies prioritize maximize positive and minimizing negative externalities within the investment portfolio.
While ESG wasn’t a significant focus for institutional or retail investors a decade ago, a McKinsey & Co study finds that “at the start of 2016, sustainable investments constituted 26 percent of assets that are professionally managed in Asia, Australia and New Zealand, Canada, Europe, and the United States.” The study notes three significant factors behind the rise in sustainable investment:
- Enhanced Returns: Studies show that sustainable investment equities strategies produce better returns with less risk than traditional strategies.
- Strong Risk Management: Focusing on investments that create positive social change, investors mitigate headline and market risk in their portfolios.
- Aligning interests with beneficiaries and stakeholders: We think this is the most significant reason of all: Institutional Investors (Pensions, Endowments) exist to manage capital on behalf of beneficiaries and stakeholders on a long-term basis. These institutions are able to satisfy their stakeholders’ demands by deploying capital in a way that produces desirable environmental and social outcomes. Ultimately this change is driven by consumers who value impact.
The last bullet point is even more of a factor in Europe, where regulation such as IORP II requires pension managers to disclose how they use ESG factors in their risk management systems. The EU High-Level Expert Group on Sustainable Finance’s Final Report calls for further legislation to “clarify that the fiduciary duties of institutional investors and asset managers explicitly integrate material ESG factors and long-term sustainability.” This is a significant shift in imagining the role of investment companies: from one of being responsible for delivering future returns to one of being responsible for the quality of that future.
While we don’t expect the political climate in the US to produce similar legislation in the US, we see signs that adoption of sustainability principles are taking hold despite a lack of leadership from the federal government:
- 2,160 Businesses and Investors have pledged to support the Paris Agreement despite the US pullout.
- In 2017, nearly half of Fortune 500 companies had climate or clean energy targets and more than 100 Fortune 500 companies disclosed the use of an internal carbon price.
- 414 US Asset Managers, Asset Owners and Service Providers have signed on to the UN Principles for Responsible Investment.
The vast majority of ESG strategies involve investing in public equities — companies who disclose metrics related to their Environmental and Social impacts. The Green Bond sector is another asset class where investors can express a preference for funding Private and Government issuers creating positive environmental outcomes.
The infrastructure sector surprisingly lags behind the public equity and fixed income sectors in ESG presence, despite the fact that infrastructure sources are responsible for over 60% of Global Greenhouse Gases. According to the UN PRI, the challenges for integrating ESG metrics into clean infrastructure investment vehicles include:
- Difficulty weighing the value of different environmental and social outcomes across regions and investment horizons. For example, how does one determine whether it is more valuable to mitigate a unit of greenhouse gas emitted in Germany in 2020 versus electrifying a village in Rwanda in 2025?
- Difficulty applying a consistent rating framework across unique investments. There are no standardized ESG metrics for the infrastructure sector.
- Monitoring investments to ensure that the anticipated benefits are realized.
Urban Matrix One is the first company to use explainable Artificial Intelligence to attempt to solve these problems. We use unique data sets and algorithms to estimate and monitor environmental, social, and economic outcomes for global infrastructure investments. We allow investors to customize their priorities and compare the value of different environmental and social outcomes. We enable investors to monitor the environmental, social, and economic returns of their investments in real time. We believe these tools will allow asset managers to capitalize on institutional and retail dollars devoted to ESG strategies and put this capital to work creating a more sustainable world.