Unlocking private-sector funds for growth

FOR the last three years, dozens of countries have gathered each July to present their national plans to achieve the Sustainable Development Goals (SDGs). At the latest of these United Nations HighLevel Political Forums, governments rolled out impressive blueprints — almost none of which included realistic budgets or revenue sources.

Estimates of the development investment gap are typically in the trillions of dollars, while official development assistance is hovering around US$140 billion per year. One effective way to help close this funding gap is to catalyze substantial investment from the private sector.

The private sector has long played an integral role in poverty reduction and economic development — a role that extends well beyond finance. Private companies create 90 percent of jobs in the developing world and facilitate improved efficiency, technological adoption and innovation, and the distribution of goods and services.

Private-sector financing of the SDGs would occur via established institutional investors, including pension funds, sovereign-wealth funds, and insurers, which together represent trillions of dollars of “patient capital.” Yet, as it stands, institutional investors allocate only a small share of assets to so-called impact investing, while channeling huge sums toward a relatively small number of public companies.

The key to achieving the SDGs is thus to impel public companies to account for environmental, social, and governance (ESG) criteria relevant to the SDGs in their decision-making. This approach recognizes the need to adopt a longterm perspective when implementing the SDGs, even as we respond to their urgency.

The good news is that ESG-anchored investing is already on the rise, with most of the major institutional investors integrating ESG factors into their investment strategies, at least to some extent. The 2016 Global Sustainable Investment Review reported that US$22.89 trillion worth of assets were “being professionally managed under responsible investment strategies” worldwide, up 25 percent from 2014. Europe accounted for US$12 trillion, and the US total was US$8.7 trillion, though the highest growth rates were in Japan and Oceania.

Viewing ESG awareness as a way to mitigate risk and even as a source of upside opportunities, institutional investors are seeking to bring this approach into their mainstream activities. This bodes well for the SDGs, but there are still important challenges to overcome, beginning with an inadequate understanding of the link between ESG standards and the SDGs.

Only a few investors and businesses are currently using SDGs as the basis for sustainability-focused strategies. But the only way to boost shareholder value and contribute to meeting the SDGs is for companies and investors to ensure, in advance, that they focus on ESG standards that are both material to their industry or business and useful to advance the SDGs.

Long-term view

In a recent paper, Gianni Betti, Costanza Consolandi, and Robert G. Eccles map the relevant ESG issues identified by the Sustainability Accounting Standards Board (SASB) in 79 industries in ten sectors, grouped by SDGs. Companies that use this kind of mapping will understand to which SDGs they would be contributing by performing well on their chosen ESG criteria.

By reviewing data on companies’ ESG performance, investors can see how their funds are contributing to achieving the SDGs. Based on this information, they may decide to reallocate their resources or to engage with better-performing companies.

In 2016, Mozaffar Khan, George Serafeim, and Aaron Yoon created portfolios of companies that were performing well and poorly on the material issues in their industry. The firms with the highest annualized active return (alpha) of 4.8 percent were performing well on the material issues and poorly on the immaterial issues. Those with the lowest alpha, -2.2 percent, were performing poorly on both. Critically, however, the divergences did not start to appear until after 7-8 years.

This demonstrates that executives must balance attention to short-term performance with a long-term perspective. That includes an understanding of which ESG issues will be material to their industry in the future, and which SDG efforts in those areas they may serve to advance.

Investors could consider taking a longterm view with regard to the financial performance of their ESG-based portfolios. They can expect periodic reports on ESG performance and its contribution to the relevant SDGs in order to monitor progress and make adjustments.

In many ways, private firms are already contributing to the SDGs, but they are doing so in an ad hoc manner that is not adequately labeled or targeted. By creating smart, comprehensive, and clearly defined strategies, private companies can not only get credit for their efforts; they can also help governments to establish realistic budgets and clear financing plans for the SDGs.

Mahmoud Mohieldin is Senior Vice President at the World Bank Group. Svetlana Klimenko is Lead Financial Management Specialist at the World Bank Group. Copyright: Project Syndicate, 2018. www.projectsyndicate.org