Sustainable investing in capital markets: A strategic approach

Can capital markets support sustainable development? How can value be defined, managed and measured to promote sustainable financial decision-making? Such questions are of interest to social analysts, businessmen, investors and citizens. The aim of this research project is to provide a formal economic framework for analyzing the relationship between capital markets and sustainable development.

Growing public concerns over the depletion of natural resources, the degradation of the environment, climate change, water scarcity, the collapse of fish stocks and the and chronic loss of biodiversity shows that it is important to think formally about the implications of sustainable development for capital markets.  Sustainable development is about meeting the needs of today without compromising the needs of future generations. It requires the integration of environmental, economic and social priorities into policies and programs at all levels - citizens, industry, and governments.

The challenges posed by environmental sustainable development demand a more holistic approach for understanding the key role capital markets can play for promoting a sustainable economy. Economy’s capital assets also include Natural Capital, which is the productive base of our economies.  The role of capital markets should be an efficient allocation of economy’s capital assets over time (Fama, 1970).   Since sustainability issues often have long-term financial impacts, it becomes a matter of financial prudence to consider both environment-related risks and opportunities in capital planning decisions. Sustainable investing could become a major force influencing how capital markets contribute to sustainable development (Krumsiek, 1997; Kiernan, 2009).

In this paper, we develop an economic framework that analyzes the effects of integrating environmental sustainability issues into investment decisions in capital markets. We show that investors' environmental awareness affects wealth accumulation through the joint working of three forces: the portfolio effect, the saving effect and the environmental-hedging effect. The propensity to consume has mixed response to investor's environmental awareness.  The propensity to consume decreases as the expected growth rate of the environmental degradation increases. Higher rate of saving can result from both a greater investors' environmental awareness and an increased environmental degradation.