Sustainable investing needs to take a much more nuanced approach today than it did in the past, according to Edward Vaughan Dixon, head of sustainability and private markets at Aviva Investors, during the Canadian Investment Review’s 2024 Risk Management Conference.

Environmental, social and governance strategies should result in a holistic view of the risks behind a particular asset or fund, he said, noting there will be trade-offs for investors, such as the cost trade-off associated with sustainable funds.

“[We’re starting] to see real increasing demand from asset owners that have made net-zero commitments, but as we get into actually delivering these funds that have been designed over the last few years, we’re beginning to realize that [they’re] moving ahead of policy. And if you move ahead of policy, you’re taking risk. And that risk . . . is that, as policy catches up, it will pay off. But that’s a bet, so there’s a trade-off.”

Read: 2024 Global Investment Conference: Global energy interests posing challenges to institutional investors’ net-zero targets

This isn’t necessarily the case in private markets, added Dixon, where sustainable investment is about being one step ahead of policy while understanding where new technologies will land and where opportunities will arise.

“If we think about how that’s emerged, it’s really a mixture of government policy, investment in research and development and innovation that has started to stimulate some of the key sustainable investing markets and the private markets.”

Institutional investors can draw from history to find points where regulation changed the game in certain sectors directly related to ESG investing. In the 1960s, there was increasing regulation around home building. The 1970s saw the invention and first applications of solar panels, which led to the creation of commercial solar farms, as well as an energy crisis that led to wind power becoming a commercial and investable opportunity in the U.S. In the 1990s, voluntary sustainable building standards started to penetrate the market, introducing more options for investors that wanted to be certified in this area. And in the 2010s, government policies like feed-in tariffs and the renewable heat incentive helped de-risk new technologies like solar and heat, making them suitable avenues for institutional investors.

Read: Majority of global institutional investors implementing sustainable investing: survey

The same could be said for the emergence of mega-scale hydro and offshore wind projects, which also saw de-risking through government investment in innovation, said Dixon. And this decade is seeing the same effect in the commercial office market, with investors beginning to see the potential for green premiums through sustainable real estate. Looking ahead, he suggested emerging technologies in hydrogen and small-scale nuclear power may be the next investable opportunities over the next few years.

Two significant advantages of investing in private market funds compared to public market funds is it’s the purest way to invest in sustainability and impact, noted Dixon, particularly when considering the impact the investment will have on the real world. For instance, private markets offer exposure to critical technologies that deliver the energy transition.

“There is no simpler way to invest in the energy transition than to invest in funds that are investing indirectly in those assets. But this, of course, comes at a cost.”

That cost is illiquidity relative to public markets, he continued. In most cases, there’s a longer duration for private market investments, which often requires initial capital outlay. However, once institutional investors accept those trade-offs, they’ll be able to realize long-term opportunities that deliver sustainability and impact, as well as risk-adjusted and market standard returns.

Read more coverage of the 2024 Risk Management Conference.