Sustainable Asset Classes

Investors have a wide variety of investment vehicles at their disposal to invest in a sustainable manner. Our last couple of blog posts focused on two of these sustainable investment vehicle, namely green bonds and impact investing. This week, we take a step back and go through an overview of the main sustainable asset classes available today.

The first sustainable asset class relates to cash and cash equivalents. This is one of the most basic and safe asset classes, and typically consists of liquid and interest-bearing instruments such as bank or credit unions deposits. Through cash deposits, investors can help banks and credit unions that incorporate sustainability in their lending operations. For example, certain bank and credit unions support local and sustainable businesses, provide loans to individuals in developing countries, or support energy efficiency. Through deposits in these banks and credit unions, investors indirectly support these sustainable activities.

The second sustainable asset class relates to fixed-income. It refers to investments that pay fixed interest or dividend payments until maturity, and includes investments such as government and corporate bonds, certificate of deposits, and money market funds. In recent years, there has been a great development of sustainable fixed-income products, such as green bonds and development bank bonds. On the one hand, green bonds are debt instruments whose proceeds will be applied exclusively to finance or refinance projects with positive environmental benefits. On the other hand, development bank bonds are typically issued by multilateral development banks, and usually fund climate-related infrastructure in developing countries.

The public equity market consists of publicly traded stocks of large corporation. Investors can incorporate sustainability into their stock portfolio by investing in equity funds that address sustainability issues. For example, there are funds that seek outperformance by integrating material ESG risks and opportunities. There also exist thematic funds that invests in companies that address sustainable and climate-related themes, such as clean energy, water, and sustainable agriculture. Moreover, engagement equity funds focus on delivering impact through shareholder engagement. That is, rather than investing in companies that already do well from a sustainability perspective, these funds invest in companies which may be on the lower end of the spectrum, with the aim to deliver improvement from within.

Private equity consists in investment in unlisted companies and is one of the fastest growing sustainable investment class, as it is an effective way to finance companies that develop and market products or services that have a positive environmental or social impact. Moreover, private equity investors often have significant ownership stakes in companies, giving them a lot of power over their investments. However, it is more difficult to implement, and is generally only available to institutional investors, venture capitalists, and high-net-worth individuals.

Another sustainable asset class relates to real estate, which is one of the most polluting industries. Indeed, roughly 40% of the global carbon emissions result from real estate. Therefore, real estate is one of the most crucial asset class when it comes to reducing carbon emissions. Sustainable real estate funds can dramatically cut housing emissions, both through new construction and via the rehabilitation of existing structures, by focusing on energy efficiency and the use of renewable energy sources.

Commodities trading as an asset class is directly tied to natural resources and agriculture but is currently primarily focused on contracts speculating on the future price of these resources. Indeed, very few opportunities to incorporate sustainability factors into commodity trading exist. The only exception is the recent formation of carbon-trading markets, whose sole objective is to address the environmental problem of global climate change. However, commodity trading potentially offers unique opportunities to incorporate sustainability, for example through pricing mechanism for the environmental impacts of resources, or by providing pricing stability for natural resources.

Sources:

Institute for Responsible Investment (2021). Handbook on Responsible Investment Across Asset Classes

Credit Suisse (2021). The sustainable asset class universe

Sebastian Utz (2021). Lecture

Martin Nerlinger (2021). Lecture