Sustainability funds are in high demand, but what is driving investors to them and how can the concerns about returns be addressed? Anastasia Petraki and Grace Canavan explain.

We have all heard the story: sustainable funds are in high demand. By the middle of 2021, their assets had reached an unprecedented $2.3 trillion, mainly driven by continued growth in the European fund market.

Net sales in the first half of 2021 overtook those in 2020, which were more than double those in 2019, which were more than double those in 2018. Such spectacular growth could be driven by several things, such as solid performance (particularly in 2020), new fund launches, or existing funds being repurposed to add a sustainability tilt. The fund sales numbers would indicate that it is not just a function of increasing supply. Retail investors genuinely want to buy more sustainable funds.

Environmental impact matters

According to the Schroders Global Investor Study, the most important driver of interest in sustainable funds is the environmental impact. The potential for higher returns matters, but it comes further down the pecking order. This is consistent across regions, but notably, investors in Europe, which has the largest sustainable fund market worldwide, are less likely to be influenced by return expectations than other regions.

In all regions and most countries, only a small percentage of people are put off sustainable funds because of performance concerns. Interestingly, performance scepticism is higher in countries traditionally associated with sustainability, such as Sweden, Denmark and Germany. US and Chinese individuals, by contrast, seem to be less put off by worries about performance.

Return concerns exist

Retail investors are quite open to the possibility of their entire portfolio shifting to sustainable funds (assuming the same level of risk and diversification). Again, their reason for feeling positive about this suggestion is less about performance and more about positive impact. However, return concerns are the biggest hurdle for the small percentage of people who feel negative about the idea.

Indeed, when it comes to why people would feel positive or negative about the portfolio shift, the responses are very consistent across the board. For people who are optimistic about it, impact ranks ahead of returns in driving that view. But for people who feel negatively, return concerns dominate. This result is independent of region, age group and investment knowledge.

Sustainability as an investment input and output

The question is: should people expect a specific level of return from sustainable funds? Broadly, there are two groups of people. The first group views sustainability as that little extra – that magic ingredient that can lead to higher returns. The second, much smaller group are those who view sustainability as a portfolio constraint and, as such, can only lead to a worse or suboptimal risk-return outcome than if there were no such constraint.

What they both have in common, however, is that they view sustainability solely as an input. But what if sustainability is also an output?

We could think of sustainability as an outcome where sustainable business models can identify trends, risks and opportunities and adapt in an ever-changing environment. This is how value is created.

Investors have many tools at their disposal to assess which businesses operate sustainably. Some tools involve financial metrics, some non-financial. Some cannot even be adequately quantified, like culture. Taking sustainability factors into consideration is about broadening the toolkit and using multiple lenses to assess if a company is likely to continue operating and growing.

A company that is harming people and the planet while creating profits is not sustainable. Its social licence to operate will expire sooner or later through litigation, consumer action, policy action etc.

There are different approaches one could take to get to address this and achieve sustainability. One may involve screening, another may involve targeting an outcome alongside returns such as impact or thematic investing. Yet another may involve active ownership, which is using your influence as an investor to help a company improve and become more sustainable.

At the end of the day, it matters very little what road to sustainability one takes. It is the end-station that is important: sustainable businesses underpin sustainable returns.

Anastasia Petraki is the Head of Policy Research at Schroders.

Grace Canavan is the Head of Intermediary Business Development at Schroders.

A version of this article was originally published at thefmreport.ie.