Sustainability becomes more important for investors in recent years. This study examined three sustainability risks—environmental, social, and governance (ESG)—which the investors take into consideration before any decision making. It is found that while environmental risks negatively affect excess returns in some years. However, since 2018 investors valued environmental risks, social risks were found to be the most influential factor negatively related to excess returns. Corporate governance risks have been found to be embedded in the traditional systematic risk factor “beta,” but no evidence has been found for negative correlations between corporate governance risks and excess returns of stocks. It is also observed that solar energy companies have achieved the highest returns, followed by low-carbon and wind energy producers. Those results insinuate that investors value the solar energy production method as the most cost-effective green energy production technique.
TopIntroduction
Climate finance seeks to support of actions that will address climate change issues. The Kyoto Protocol 1997 and the Paris Agreement 2015 call for financial assistance from parties with more financial resources to those that are less endowed and more vulnerable. This recognizes that the contribution of countries to climate change and their capacity to prevent it and to cope with its consequences vary enormously. Climate finance is needed for mitigation because large-scale investments are required to significantly reduce emissions. The Paris agreement sets the goal of zero net greenhouse gas emissions from human activity. Each party is obligated to set targets for emissions reduction or limitation, implement domestic measures to achieve those targets, and submit data on its progress for international review and evaluation (Rafay, 2022). The second milestone of 2015 was the adoption of the Sustainable Development Goals (SDGs) by the 194 countries of the UN General Assembly addressing global social issues and environmental challenges that threaten the sustainability of human society. Global goals were set, including poverty eradication, good health and well-being, quality education, clean energy, sustainable cities, responsible consumption and production, and action on climate change. Amid these changes corporate managers began to embrace environmental management, equal opportunity, work-life balance, labor rights, and other socially responsible policies as integral to the management of business risks and opportunities. At the same time, investors began to recognize the importance of ESG (Environmental, Social and Corporate Governance) risks in investment decisions. ESG holds social and environmental responsibilities to corporates that used to sanctify revenues and profits above all other corporate goals and missions ensuring the long life of a company through a combination of financial profitability, environmental protection, and social responsibilities. ESG investment is a set of global guidelines drawn up under UN leadership is stating that investment managers should incorporate ESG factors when making investment decisions and are required to provide information representing their approach to responsible investment. According to Kawaguchi (2017), incorporating ESG factors mean including issues relating to the environment such as: carbon emissions, energy efficiency, resources efficiency, recycling, water resources, renewable energy, preservation of forests and marine resources. Social issues including workplace diversity, working conditions across the supply chain, force labor and modern slavery. Those policies which were regarded as additional costs factors are now being treated differently, since mounting threats to humanity such as climate changes and wealth gaps are now being recognized by consumers, stakeholders, corporates workers and governments.
There are two important aspects of the impact of sustainability on the financial markets as a whole and on the investments and portfolio construction. First, investors are more concerned about ESG issues and prefer to invest in firms that are ware of these issues and are willing to invest resources to reduce their sustainability risks. Second, more and more investment houses are stating that they will not continue to invest in companies that harm the environment. For example, in July 2021, “Altshuler Shaham” which is the largest investment house in Israel, has announced that it intends to end its investment in companies with more than a quarter of their revenues in the future in carbon. Moreover, the investment house argued that the move is not due to climatic activism, but to an economic perspective, in their view, “climatic risks are investment risks”. Such important move from the leader of the institutional investors that dominates the financial market would essentially drive companies to take care of their environmental issues. However, this revolution had not come without protest and debates initiated by private investors that uses the services of those institutional investors. In their view, not investing in high ESG risk stocks may harm returns on their portfolios and eventually massive abandonment of that investment house by unsatisfied customers. “Altshuler Shaham” is the first swallow in Israel that may be followed by other investment houses. A massive joining this movement by private and institutional investors can really change the world by forcing companies that seek public funds to better care about sustainability issues.