In the age when threats of climate change and global warming are pressing, every government and business must know about AI potential for promoting sustainable investing
The capabilities of artificial intelligence (AI) are mesmerising. Come to think about it, it is no wonder that people are afraid to be substituted by AI one day, considering the scope of the tasks it’s able to perform. The smart technology is currently applied in all possible industries and spheres. And yet, when AI potential is combined with sustainable investing tactics, its application becomes more than meaningful.
For the sake of the common good, many companies consider implementing AI in their ESG investing practices. Therefore, making a change is now easier than ever. For those of you who are not sure whether to grab the opportunity or not, here is our detailed review of how AI can facilitate sustainable investing for all parties involved.
What is sustainable investing?
In the age when threats of climate change and global warming are pressing, every government and business knows what sustainability is. The notion encompasses the preservation of natural resources as well as maintaining an ecological balance needed for the planet and humanity to survive.
How does that relate to investing? Sustainability or ESG investing refers to investment strategies that direct capital to sustainable infrastructure projects, and other companies that seek to combat climate change and environmental destruction, while also promoting corporate responsibility.
Approaches to sustainable investing vary. The most popular sustainable investment strategies include:
- negative screening – excluding specific non-eco-friendly companies or sectors from a fund or portfolio,
- positive screening – selecting required sustainability-related characteristics to define top-performing companies within a defined industry,
- ESG integration – including ESG risks and opportunities in financial analysis and investment decisions,
- impact investing – concentration on positive social and environmental outcomes rather than profitability of the investment,
- portfolio tint – select ESG investments from across the index for them to prevail over non-ESG ones, while maintaining the same level of risk,
- shareholder activism – investors encourage the companies they invest in to pursue ESG opportunities or buy corporate equity to transform the company’s operations into more sustainable ones.
Sustainable investing is in demand
According to the Insider Intelligence forecast, sustainable (ESG) investing will remain a high priority for investors, asset managers, and banks this year and likely in the coming years as well.
Over 80% of institutional investors in the US and Europe plan to increase their funding of ESG products over the next two years, while about two-fifths (41%) of banking executives globally believe ESG investments are connected to their greatest opportunities.
At the same time, both employees and consumers are paying attention to corporate ESG practices. In a recent Kearney survey, a quarter of respondents claimed they would leave their bank over poor environmental and social track records.
Sustainable investing is important for all stakeholders. On one hand, it empowers investors with low risk levels along with a high sense of purpose and meaningfulness. On the other hand, it helps companies promoting sustainable technologies and practices to strive and get access to funding in a competitive environment.
Although researchers continue to explore the relationship between ESG investment strategies and investment returns, early results show that sustainable investing appears to have a positive effect on investors’ gains. In 2020, the median total return on equity funds of sustainability-focused companies exceeded that of their peer funds by 4.3%.
It may seem that the situation with sustainable investing is a win-win for all. However, ESG investments are still not mainstream enough. The problem is that the sector has some pertaining issues preventing more investors from hopping on the bandwagon.
What is wrong with sustainable investing today?
Overall, sustainable investing trends are illustrating positive growth. The latest (2020) biennial Global Sustainable Investment Review from the Global Sustainable Investment Alliance (GSIA) showed that ESG-related assets under management grew by 15% in two years and reached US$35.3 trillion. In total, that equals 36% of all professionally managed assets across regions covered in this report (US, Canada, Japan, Australasia and Europe).
Unfortunately, the picture won’t be complete without another puzzle piece. Large-scale organisations that can potentially be major contributors to the cause shy away from sustainability investments.
The new report from the Capgemini Research Institute, ‘A World in Balance – Why sustainability ambition is not translating to action’ revealed that the level of investment into sustainability initiatives for companies with over $20 billion in revenue is just 0.41% of total revenue on average. Only one-fifth (21%) of the respondents believe that the business case for sustainability is clear, while 53% believe that the cost of pursuing ESG initiatives outweighs the potential benefit, despite statistical evidence of the opposite results.
Moreover, fears of being accused of greenwashing force banks and financial institutions to be increasingly careful about their “green” investments and carbon offsetting practices. The segment fiercely fights the lack of data, clarity and transparency over what constitutes a sustainable corporate policy as well as the practical results of a company’s ESG strategy. Therefore, many organisations lack a collective vision and coordination around sustainability efforts both across their operations and across their investment portfolios. Banks often do not understand how to correctly assess long-term risks and rewards within their sustainability investment practices.
Regulators question ESG reporting standards
Meanwhile, global regulators are implementing stronger scrutiny of ESG funding and practices. The EU finalised its ESG investing rulebook last year, although further clarifications may still be needed.
This year, the UK has enacted the Financial Services and Markets Bill 2023 which clarifies sustainability disclosure requirements (SDR). The country also announced that it would be establishing a mechanism for formal UK endorsement and adoption of the ISSB standards adopted on 26 June 2023.
At the same time, in the US, the ESG regulatory landscape is uneven. A growing number of states are passing laws to restrict the use of ESG factors in making investment and business decisions, especially when it comes to state pensions and other fiduciary funds. The industry now awaits a final ESG disclosure rule for funds and advisers from the US Securities and Exchange Commission (SEC).
Due to the stricter classifications adopted, asset managers across the world are pressured to rethink what constitutes ESG investment and reshape their portfolios. However, they may still lack adequate data and actionable insights for proper ESG-focused investment results. That’s where artificial intelligence can come in handy.
Artificial intelligence (AI) enhances and simplifies the investment process
As investors are increasingly seeking measurable ESG impact of their investment decisions, they need a technology able to handle loads of data such as AI.
Artificial intelligence (AI) allows intelligent technology systems to perform creative functions traditionally considered the prerogative of a human being, e.g. to learn from their own experience, adapt to the defined settings/parameters, generate original content, and perform human-oriented tasks. It is often utilised in all industries, including fintech.
When it comes to investing, the technology helps the companies effectively scrutinise the large volume of financial information to gather valuable insights. Besides, the innovative generative AI tools (similar to ChatGPT) increasingly help both traditional and crypto investors choose, manage and change the assets in their portfolios, automate trading, and reasonably control the risks involved.
The reasons investors consider AI usage include saving time on research and the ability of technology to make better, unbiased decisions. Moreover, 43% of AI proponents believe that artificial intelligence is the future of investing.
AI has even more utility for sustainable investing than other investment types
It is already clear that many investors strive to make a positive ESG impact with their investments besides earning money. However, they need to be equipped with the right information to make truly informed decisions.
Corporate ESG factors available for judgment are typically self-reported by the business owners. Thus, they can be easily manipulated unless externally audited. Besides, such reports typically omit more detailed information on regional ESG efforts, negative incidents, and ESG applications in separate business segments.
One benefit of AI is that it can analyse disparate datasets of unlimited volume and create a fuller and more accurate picture of the firm’s ESG activities. Along with official reports, AI tools may take into account social media posts and comments, news reports, GPS or satellite imaging, and more. This way, AI-enabled analytics can fill some of the ESG disclosure gaps.
In addition, AI sentiment analysis and natural language processing algorithms have the potential to analyse the tone of ESG-related business conversations and texts and determine the company’s commitment to ESG goals and objectives. Although that’s not measurable data, understanding managers’ intentions adds more to the corporate profile.
Furthermore, predictive AI models are able to forecast, simulate and automate everything related to stocks, pricing, promotions, assortment, or carbon emissions of a company based on available data and trends. Even if the company doesn’t provide publicly available ESG data, predictive analytics can help investors understand industry average carbon emissions, or figure out approximate emission values based on parameters disclosed by similar companies.
By complementing traditional risk analysis, AI has the power to improve sustainable investment decision-making. Artificial intelligence can analyse thousands of media and other sources of information daily, discovering the reports of controversial ESG practices companies do not typically report, as well as estimating the current state of the company’s financial performance, rather than relying on quarterly reviews.
Moreover, AI is improving satellite remote sensing, giving it better precision and accuracy. That enables a more comprehensive understanding of the local environmental issues, leaks of greenhouse gas emissions next to a particular industrial facility, efficiency of reforestation efforts, etc. Therefore, AI-powered satellite sensors can both estimate companies’ exposure to physical risks or negative environmental impacts and better assess their own environmental impact.
Challenges to using AI in sustainable investing
Deloitte Global’s recent report, ‘Artificial Intelligence — The Next Frontier for Investment Management Firms,’ suggests that when risk management and content distribution are augmented with AI, investment management firms can rapidly transform business models, operations, and internal capabilities.
However, the firms must carefully consider a few factors currently hindering full AI deployment in both sustainable and general investing. These include:
- Data privacy and security. When AI tools analyse volumes of different data, regulators and data owners want to make sure the AI providers handle it responsibly and within legal norms. Therefore, ChatGPT creator – OpenAI – has witnessed a wave of regulatory scrutiny and temporary bans. Its legal status and the position of similar technology within privacy norms are still uncertain.
- Transparency, accuracy and accountability. Firms using AI for any purpose must implement safeguard mechanisms to prevent the spreading and promoting of misinformation. As those who have tested ChatGPT at early stages know, AI chatbots are not always 100% correct in their responses. That’s why certain given data should be verified, especially if the source of information is unknown. Besides, sustainability-focused investors would like to see AI providers bear clear responsibility for the outcomes of their models and data, as well as make the algorithm logic or legal grounds for data access more transparent. That is not always the case, as open information about the technology hinders its market competitiveness.
- Ethics. There are many ethical dilemmas surrounding the use of AI. For instance, AI systems often deliver biased and stereotypical outcomes if they rely on the most popular search results. AI-enabled data gathering may be treated as a form of surveillance infringing one’s privacy rights. The list may go on and on. For investors, aiming to transform the lives of local communities and make the world a better place, it is crucial that decision-making is fair and impactful. Striking the right balance between automation and being guided by the common good is often challenging.
- Lack of industry standards. Although AI estimations of the company’s ESG practices may be more accurate than corporate reports, the lack of general rating standards diminishes the value of such assessments. There are hundreds of third-party ESG rating agencies on the market and each has its own criteria for assessing ESG performance. Thus, AI analysis just adds to the list of possible evaluations of the investment’s sustainability.
- AI itself is not eco-friendly. Despite all the benefits, storing data and refining AI models and algorithms through lengthy training is energy intensive.
Who leverages AI in sustainable investing?
As all the theory is laid out clearly, it’s time to refer to practical use cases. Despite the regulatory uncertainty and other obstacles, some firms are carefully testing the waters of emerging technology with promising yet mixed results.
Robeco
Quant manager Robeco, which has $170 billion in assets under management, started experimenting with AI tools for sustainable investing purposes as well as quantitative credit. The company claims the majority of its investing strategies are integrating ESG.
In the interview with Institutional Investor, Patrick Houweling, co-head of quantitative fixed income at Robeco, said that early results show that machine learning can significantly improve risk-adjusted returns for strategies that use the value factor. At the same time, the firm acknowledges that there were many situations while testing when researchers were not clear as to why a neural network had come to a particular decision. Therefore, they remain very cautious about the bias that might creep into AI systems.
Clarity AI
Clarity AI, a sustainability-focused technology platform, is leveraging machine learning and artificial intelligence to present a detailed ESG picture of a company, investment funds, or governmental policy. The technology enables the firm to collect and analyse huge volumes of data and deliver actionable insights. As of May 2023, Clarity AI’s platform analysed more than 70,000 companies, 390,000 funds, 198 countries, and 199 local governments.
In March 2023, the company teamed up with Swedish BNPL fintech Klarna to deliver more comprehensive ESG metrics about customers’ electronics purchases, including information on brands’ greenhouse gas emissions, energy derived from renewable resources, and more.
Summary
Sustainable (ESG) investing remains a high priority for investors, asset managers, and banks. ESG-related assets under management are consistently growing. However, a lack of data, clarity and transparency in ESG reporting prevents many organisations from participating in sustainable investing. AI can analyse disparate datasets of unlimited volume, forecast or simulate a company’s ESG performance, determine the risks with high accuracy, and more. At the same time, the technology still has many shortcomings preventing its mass adoption for the purposes of sustainable investing.
