The past year has seen a marked shift in society’s attitudes toward sustainability. This shift is spurring political pressure, a regulatory push and technological advancements to create the foundations of a more sustainable world, leading to a change in investor behavior and setting in motion a major yet gradual capital reallocation. Society’s long transition toward the practice of sustainable investing is likely to drive market adjustments for years and even decades.
Key takeaways:
• A commonly held view is that a return sacrifice is necessary when adopting sustainable investing because the shift is already embedded in current market prices. We disagree.
• The fundamental point often overlooked is the concept of a long transition between now and a future state, driven by investment flows, as sustainability effects become embedded in market pricing. Because these flows are in their early stages, we believe that the full consequences of a shift to sustainable investing are not yet in market prices. Assets backed by high sustainability will become more expensive while others will become cheaper during the transition period, in our view, meaning that those holding sustainable assets will earn a return benefit during this transition.
• Many investors focus on what evidence of a sustainable investing impact can be found in historical data. We believe historical data does not tell us the full story: society will care much more about sustainability in the future than it has in the past, and this will be the key driver of investment flows and asset returns.
• The lack of historical data linked to sustainability makes it hard to quantify these effects. But we have observed other slow-moving, new trends that have had profound effects on asset prices in the past. Our work is grounded in the academic literature that finds financial markets are imperfect at pricing in information about the far-off future, even when the structural shifts – such as demographic changes – are well understood.
• Sustainability effects and societal attitudes will impact all assets and therefore the whole portfolio. The direct impacts of climate change and the coming capital reallocation will reshape economic fundamentals, expected returns and assessments of risk. Strategic asset allocation (SAA) decisions need to incorporate these implications in ways that go far beyond simply screening out certain stocks or securities. The lack of historical precedence makes it paramount to account for higher uncertainty when building sustainability-aware SAAs.
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