Companies can adopt internal investment criteria for corporate investments based on their sustainability strategy. Over time, these criteria can become another “hurdle” rate for investments, alongside the traditional internal rate of return (IRR), focusing on positive SDG impact and management of downside ESG risks.
Here are different ways to integrate sustainability into investment-decision processes.
Integration into Capital Allocation Methods
The most straightforward approach to SDG investment criteria is to integrate the SDGs into traditional capital-allocation processes, such as IRR, net present value (NPV), and payback period (PB). This can be done in two complementary ways:
Translate sustainability into financial analysis. This approach entails a financial valuation of sustainability benefits to fit into traditional capital-allocation methods. For example, climate mitigation results in energy efficiency, thus increasing IRR. Lower pollution reduces regulatory risk, and therefore increases NPV.
Evaluate sustainability and financials side by side. Here, SDG impact is considered as a stand-alone criterion for investment, along with financial criteria. According to the Accounting for Sustainability (A4S) CFO Leadership Network, this can be done in several ways:
- Minimum threshold. Investments are conditioned upon meeting a minimum level of material sustainability issues.
- Relative performance. When investments have similar risk-adjusted returns, those with higher sustainability profiles should be favored.
- Lower hurdle rate. A lower hurdle rate is applied to investments with a higher sustainability profile, reflecting intangible benefits that cannot be valued financially.
Internal Taxonomy
Governments around the world are introducing taxonomies of green and sustainable assets to promote financial and corporate investments in sustainable development.
Companies use these taxonomies internally to understand and report the percentage of their investment that is taxonomy compliant and identify activities eligible for green or sustainable use-of-proceeds financing.
Companies can also develop internal taxonomies—adapted to their specific sector and location—and use them as criteria for sustainable investment.
Portfolio Management
Traditionally, active corporate portfolio management is used to continuously adapt the strategic focus of the company and increase investment in more profitable businesses. In the sustainability space, active corporate portfolio management can be used to refine the strategic contribution to the SDGs and increase exposure to businesses with a positive contribution. Instead of looking at the sustainability of each business line separately, managing the corporate portfolio actively involves a broader approach that takes into account every piece of the portfolio and how it fits together to form a unified impact thesis and strategy.
