SRI is a not an unfamiliar concept for the Middle East region, as it is largely underpins Islamic investment strategies. The concept calls for negative screening to avoid investments in “sin” industries such as alcohol, gambling, weapons or tobacco. In the modern world, which is battling an obesity epidemic, investors are even avoiding companies that do not adopt regulations on limiting harmful sugar and fat content.
ESG refers to issues that an investor may consider when making an investment. Such companies are more likely to outperform their peers in the long run.
Environmental issues include those created by companies that have a negative impact on the climate, that increase resource depletion, generate waste and pollution, and promote deforestation and other destructive activities. On the positive side are business activities that avoid or minimise environmental degradation and lower costs though better efficiencies.
Social issues refer to the company’s relations with its employees and consumers. This includes working conditions, health and safety standards, product integrity, and other matters.
Governance deals with a company’s leadership, executive pay, bribery and corruption, minority shareholder rights, tax compliance and the like.
A potential green investor would use a combination of SRI and ESG. SRI parameters would screen out industries in which investment would not be considered “green”. The ESG framework can be used to identify and score the performance of sustainable companies that also deliver solid investment performance.
Alternatively, investments can be spread across companies that manufacture products like renewable fuels and energy-saving technologies. According to a Morgan Stanley survey, 84 per cent of millennials are looking for investments with a focus on ESG impact.
Typically, across a portfolio, an investor could be looking to invest in renewable energy, solar and wind installations, low carbon and cleantech companies that pioneer technologies that lead to reductions in greenhouse gas emissions, projects that enhance energy efficiency and pollution control, environmentally sustainable land and resource management, biodiversity, water and waste management and clean transport.
“The survival of many countries will be depending on how they can implement the right solutions to counter climate change. Companies at the forefront of this fight will witness massive demand for their services and products. Smart investors who can identify such companies early are likely to make very good returns,” said Simon Snelder, a Dubai-based independent financial adviser.
Professor Ted Stephenson, CFA, CFP, CPA, and a member of CFA Society Emirates, said: “There is increasing demand for green investments in the Middle East. Governments in the region are driving many green initiatives. As markets in the region move from ‘Frontier’ to ‘Emerging’ classification, more international capital will flow into the region, and international institutional investors will be looking more closely at the ESG profiles of publicly listed companies in the region. ESG is therefore important to not only investors but also increasingly to the boards and managers of companies in the region.”
How to build a green portfolio
Stocks: Globally, there is a wide range of green investment options available including stocks, mutual funds and exchange-traded funds that invest in companies in clean energy, renewables, pollution control and other suitable companies.
Bonds: Green bonds are specifically used to fund environment and climate-friendly projects. Green bonds, whose issuance was expected to hit USD 200 billion in 2018, are very popular as they often offer tax incentives and credits.
Sukuk: The United Nations has overseen the introduction a green sukuk — a bond that is in consonance with Shariah principles — the proceeds of which are used to fund specific environmentally sustainable infrastructure projects, refinance construction debt, or finance the payment of a government-granted green subsidy.
Funds: A green fund is an investment vehicle — usually a mutual fund — that invests solely in securities of companies that pursue environmentally sustainable policies.
While green investing is an attractive choice, there are cautionary tales being told of losing one’s shirt if the investments are made heedlessly.
Returns on green investments may sometimes not be as substantial as traditional investments. This can be mitigated by fine-tuning your green portfolio in such a manner that your liquidity needs can be met at any time while maintaining profitability over different investment time horizons. Also, remember your returns are not just financial, but social as well.
“The correlation between ESG rating and risk-adjusted return has turned significantly positive in recent years. There is increasing evidence that companies with high ESG ratings are good investments,” Stephensen said.
While picking undervalued stocks, investors should ensure the company has credible and sustainable long-term plans. Sometimes companies support technologies that may become less efficient over time.
“If somebody wants to build an entire portfolio on green investments, I would advise them to focus on water solutions, alternative energy, engineering/construction related to sea level increase, recycling business and transportation using green fuels,” Snelder said.
“As of now, it is quite unlikely that you will get the same returns as traditional investments if you focus only on green investments. On the other hand, if you had invested early in Tesla, Waymo and companies with water patents that can turn sea water into drinking water, you would have made exponential returns.”
Investors are also advised to beware of ‘greenwashing’, a term that refers to a company lying about or exaggerating its green credentials. A company publicises certain environment friendly products or policies, while its core business continues to pollute. Read the fine print in its accounts to see where it makes its money.
Also, make use of green bond indices to ensure that companies being invested in have solid green credentials. Barclays/MSCI and S&P Green Bond Index are two such indices that track issuers, their projects and the use of proceeds.
(Reporting by Yazad Darasha; Editing by Michael Fahy)
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© ZAWYA 2019