An Introduction to Sustainability: An Investor’s Perspective

Sustainability is a concept that has grown alongside our evolving climate crisis. It has become essential for corporate entities to position sustainability as the cornerstone of their business strategy if they seek to ensure long-term success. With tightening regulatory requirements and mounting investor pressure, sustainability appears to finally be taking centre stage. 

Well, not according to us. 93% of investors report that they factor ESG and sustainability into their asset allocation strategies. This number may look promising, but we must question the sustainability frameworks they employ, as well as their commitment to real impact. When we take this into account, the real figure is much lower. We hence believe that sustainable asset allocation strategies of today are ineffective, and leave much to be desired. 

Before we elaborate further, it would be helpful to take a look at what sustainability means.

What is sustainability?

One might be inclined to think of sustainability as a juvenile concept, something borne out of the modern ages. However, the concept of sustainability has its roots in 1710s Germany, with roots in “the long-term responsible use of a natural resource”. Going even further back, the importance of being responsible with natural resources and environmental conservation can be found in ancient Mesopotamia. The Epic of Gilgamesh, a five thousand year old Sumarian epic, makes mention of what we might assume are modern environmental issues such as deforestation and irresponsible use of nature.

The core idea of the term remains today, with an added challenge. How do we reverse the damage that we have accumulated over the centuries within economic means? 

How is ESG linked to sustainability?

ESG as a concept was developed to better quantify, measure, and most importantly compare how sustainable an organisation is, in relation to their competitors. Throughout the years, the ESG framework has become the basis for the development of other, more targeted sustainability standards. For instance, under the ‘Environment’ umbrella of ESG, numerous climate-specific standards have sprung up over the years. These standards are aimed at helping governing bodies and investors assess how companies operate, such as a company’s level of carbon emissions or the value of assets exposed to climate risk. 

The importance of ESG considerations 

ESG matters in the context of both companies and funds. ESG criteria have evolved from risk management tools to value creation opportunities, both for individual companies and investment portfolios.

Investors now recognise sustainability issues as intangible values that can have an adverse impact on profits. This is especially so when it comes to investing in sustainable companies which generally carry an all-round better reputation. This has a spillover effect on both end-consumer perception, as well as employee retention. A 2022 report by Deloitte has shown that higher ESG scores are often linked to increased EV/EBITDA multiples, drawing a link between improved ESG performance and investor confidence which then raises a company’s valuation. With these two realms boosted, sustainable companies are able to increase their market share while diminishing risk. This translates to a better performance in the stock market. 

Companies also face mounting pressure from governments in the form of sanctions and regulatory measures, such as carbon taxes. In some countries, governments have rolled out new regulations for companies to conduct mandatory climate reporting in order to be listed on stock exchanges. In Singapore, the Singapore Exchange (SGX) has mandated that all publicly listed companies must adhere to mandatory climate reporting aligned with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), starting in FY25. Mandatory disclosures further drives companies to thoroughly calculate and disclose their emissions and waste levels due to ESG risks having a direct impact on profitability.

Combining a ‘carrot and stick’ approach, companies are thus incentivized to enhance their environmental practices, both to capture financial benefits associated with stronger ESG standings as well as comply with regulations.

ESG considerations and portfolio companies

Companies incorporate ESG principles into their operations through ensuring their environmental practices, social impact and governance standards meet certain requirements. At a high level, this approach not only aligns the company with regulatory requirements and investor preferences but also builds resilience against operational and reputational risks, ultimately affecting revenue, brand image, and cost efficiency. 

Environmental practices

Many companies adopt sustainable environmental practices as part of their regular operations, the most common being carbon emission and waste reduction. Firms often set emission targets, such as the Science Based Target Initiative (SBTi), as part of their sustainability targets, with many also transitioning to renewable energy sources. Such actions can result in the reduction of cost overtime as firms minimise their climate-related losses in the future.

Social impact

Companies now have a greater focus on their employee well-being and community involvement in a bid to improve their social footprint. This is through providing moral support, fair wages and DEI initiative, and can be beneficial to a company overall by improving employee morale. This translates to greater overall productivity and organisational stability and transparency. In recent years, the public has given greater scrutiny to ethical supply chain practices, providing companies more incentive to build consumer trust and loyalty. 

Governance standards

Companies establish certain principles and frameworks that act as a compass for their decision-making. To ensure its effectiveness, governance standards have to enforce transparency and accountability in leadership, while promoting ethical practices throughout their operations. Companies are then able to establish stakeholder trust and reduce risks, improving overall performance and long-term sustainability.

Socially responsible investments (SRI) screening

In the investment sphere, ESG introduces a layer of complexity to the asset allocation process; what was traditionally an evaluation of risk and return now encompasses time and preference as well. These latter factors are crucial to support an effective ESG transition while adhering to investor appetite. Currently, having extremely strict ESG constraints leads to a less efficient portfolio and a lower efficient frontier as it reduces the investable universe. Therefore, enthusiastic investors are approaching sustainable asset allocation with caution while holding out for early-adopter gains. 

Currently, socially responsible investments (SRIs) undergo various screening approaches. Table 1 illustrates a summary of these approaches, and some benefits and shortcomings to them. 

Method	What is it	Benefits	Shortcomings
Negative screening	Excluding companies or sectors involved in activities deemed harmful	Aligns investments with ethical values, reduces exposure to potential reputational risks	May limit investment opportunities and reduce diversification, potentially impacting returns
Positive screening	Companies that demonstrate positive impact	Highlights leaders in sustainability, potentially fostering better corporate practices and financial performance	Can be challenging to identify truly impactful companies, and the focus may overlook risks in other areas
ESG integration	Incorporating ESG factors into the financial analysis alongside traditional metrics	Provides a holistic view of company risks and opportunities, potentially improving long-term investment outcomes	Inconsistent ESG data and lack of standardisation can complicate analysis; potential greenwashing risk
Thematic investing	Targeting investments aligned with specific sustainability themes	Offers targeted exposure to high-growth sectors tied to global sustainability trends	Narrow focus may increase volatility, and these sectors may face regulatory or technology-related risks
Impact investing	Directing capital toward companies or projects with the explicit intention of generating measurable social or environmental impact	Generates tangible, positive societal outcomes while pursuing financial performance; often aligns with investors’ personal values	Limited opportunities and liquidity; measurement of impact can be complex and sometimes subjective
Engagement and voting	Investors engage with companies to influence their sustainability practices and vote on ESG-related shareholder proposals	Encourages companies to improve practices; offers a proactive way to support sustainability without divesting	Requires significant resources, and results may be gradual; limited influence for smaller shareholders
Norms-based screening	Ensuring that companies align with international standards, such as the UN Global Compact or OECD Guidelines, and avoid human rights/environment violation	Reinforces alignment with global ethical standards; reduces exposure to companies with significant reputational risks	May reduce diversification; lack of alignment with standards across countries complicates implementation

ESG considerations and portfolio performance

A few studies have explored potential differences between SRI and traditional investments. Chong and Phillips (2016) found that a set of portfolios from a publicly available list of ESG stocks outperformed the S&P 500 index in the given time period. Sherwood and Pollard (2017) also found that integrating emerging market equities into institutional portfolios allowed investors to generate higher returns and reduce risk exposure when compared to traditional equity investments. When ESG factors are integrated into a portfolio beyond the Fama-French three-factor model, SRI investments yield the highest Sharpe ratios, according to a study by Maiti (2020). 

ESG integration and fund performance

When comparing impact funds to non-impact funds, we see that impact funds generally tend to perform competitively but yield mixed financial results. According to a study by Cambridge Associates, Impact funds with <$100M AUMs often achieve stronger IRR figures, with pooled IRRs around 15.7% compared to 8.5% in emerging market benchmarks. However, impact funds still do show areas to play catch-up; in traditional private equity, they are seen to lag by 2-6% in certain periods. 

However, we see that some funds like Carlyle have shown successful exits and strong annual revenue growth in their portfolio companies. Carlyle held a 29% stake in Yashili, one of China’s largest infant formula companies, and was able to help it turn around its poor reputation amidst many health scandals through establishing various ESG initiatives. Carlyle improved Yashili’s reputation and sold its equity stake for $388 million, representing 2.3x MOIC. This example illustrates that ESG integration at the fund level can be beneficial for all stakeholders involved. We see similar success across various other funds such as the TPG Rise Fund which has focused on financial inclusion, and KKR Global Impact Fund’s investments, which invests in energy transition. 

Challenges in ESG data

Obtaining accurate and reliable ESG data remains a persistent challenge for companies and investors due to issues like inconsistent data standards, potential greenwashing, and limited regulatory oversight. While many companies are beginning to report ESG metrics, differences in reporting frameworks—such as GRI, SASB, and TCFD—lead to variations in data that complicate comparisons. In 2023, for instance, companies in the EU faced challenges complying with the Corporate Sustainability Reporting Directive (CSRD) due to inconsistent emissions data, making it difficult to meet the directive’s stringent requirements.

A major factor compounding these issues is the lack of transparency and standardisation in ESG metrics, as much of the data remains self-reported and lacks mandatory external audits. This allows companies considerable control over which data they disclose and how they present it, often obscuring the true picture of their sustainability efforts. Limited regulatory oversight in many regions, where ESG reporting remains voluntary or minimally enforced, further enables companies to make exaggerated claims without significant consequences.

The complex and ambiguous nature of ESG criteria, which can vary significantly across industries, also poses challenges. This complexity often leaves investors without the expertise needed to verify every ESG claim, particularly when relying on external ESG rating agencies that apply differing methodologies. Moreover, greenwashing remains a widespread issue; a recent report found that over half of ESG-labelled funds failed to meet advertised standards, misleading investors about the genuine impact of these investments.

Looking ahead

Sustainable investing holds great potential for aligning profit with purpose, yet significant gaps in execution remain. While frameworks like ESG have attracted widespread investor interest, inconsistent data, limited transparency, and prevalent greenwashing continue to challenge both the credibility and impact of these investments. Currently, ESG fund performance lacks sufficient reliability to assure investors of delivering both financial returns and measurable social or environmental benefits. For sustainable investing to truly succeed, the industry must prioritise rigorous, standardised reporting and accountability—empowering investors to make choices that are both impactful and financially sound.

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This report is independent of the views of the National University of Singapore.

References: Aviva Investors, Deloitte, Science Direct, UBS, Bain, Carbon Trust