With 12 months to go before the final climate talks in Paris, much hope is pinned on the finance sector as a key player on “climate action”.  In September, the UN Climate Summit set the tone when some big institutional investors pledged to build low-carbon portfolios.

Among the headline announcements during and after the Summit were:

• the Swedish National Pension Fund (AP4) promised to “decarbonize” its entire equity portfolio of $20 billion
• the Swedish AP2 National Pension Fund announced in October it is pulling the plug on investments worth  $112 million in 12 coal and 8 oil-and-gas production companies;
• the California State Teachers’ Retirement System (CalSTRS), a $176 billion pension fund, announced  it would triple its clean energy investments to $3.7 billion in five years.

Something is stirring, but what defines sustainable, or “green” investing? To some extent, it depends who you ask. According to a 2012 report by the Organization of Economic Cooperation and Development (OECD), “green investing” refers broadly to low-carbon and climate resilient investments made in companies, projects and financial instruments that operate in the renewable energy, clean technology, environmental technology or sustainability-related markets as well as those that are climate-specific.

For others, sustainable investments have a broader meaning, and denote a commitment incorporating environmental, social and governance (ESG) impacts into investment decision-making. ESG is at the heart of the United Nations’ Principles for Responsible Investing, which currently has 1,314 signatories, the majority of whom are either asset owners or investment managers.

But ESG is a big tent. Crowded inside is everything from worker safety and company pollution, to excessive compensation for top executives. Within ESG, investments that specifically address climate-related risks and rewards are still a relatively small subset and hard to quantify. Nonetheless, the growing attention by institutional investors and corporations to ESG issues is noteworthy.

Sustainable investments are typically long-term investments—not quick picks for high quarterly profits. The Low Carbon Investment Registry, the world’s first public online database showing examples of global low carbon investments, analyzed 204 investments worth $24 billion and found that:

• 44% were related to renewable energy;
• 24% related to investment funds that targeted a range of low carbon activities;
• 15% were direct investments in energy efficient and low emissions buildings;
• 8% were agriculture & forestry investments;
• 7% were related to industrial processes, and
• 2% of entries related to information & communication technology or waste, pollution & carbon sequestration.

As the above breakdown shows, while renewable energy figures large; another trend within sustainable investing is a focus on real assets: tangible things like sustainably managed forests, agriculture, buildings, and water infrastructure. But it can also apply to nearly any asset class, including bonds, stocks, project financing, venture capital, private equity.

Sustainable investing has advanced most in equities. For example, Black Rock, the world’s biggest fund manager and largest holder of oil and gas equities, teamed up with London’s FTSE Group earlier this year to create a set of stock market indices that screen out fossil fuel companies. According to the Financial Times it was the first benchmark of its kind from a leading index group. Indices like this make it easier to both pick investments, and evaluate their performance, giving a real boost to green investing.

Institutional investors are leading the way. These are entities like pension funds, insurance companies, mutual funds, banks, sovereign wealth funds, foundations and endowment funds, and others. But there are still no reliable figures to quantify their involvement.

The OECD reports that institutional investors based in its 34 member countries manage $83 trillion in assets. A closer look at some of these players reveals the enormous untapped potential for green investing.

Within the OECD:

• Pension funds manage around $22 trillion of assets;
• Insurance companies manage $25 trillion in assets;
• Sovereign Wealth Funds manage around $6 trillion in assets.

A small part of that money is flowing toward sustainable investments. According to Dave Chen, CEO of Equilibrium Capital, a manager of sustainable funds for institutions: “In recent times, we are seeing the most powerful segment of the investment spectrum, the institutional investor, moving into sustainable investing.”

Pension funds are some of the biggest institutional investors around: investing billions of dollars accumulated paycheck by paycheck from millions of working people over the course of their lifetimes. The managers of these retirement savings have the obligation to serve their members well, investing their money both safely and productively.

For a long time, that meant an exclusive focus on financial returns, with so-called “non-financial,” issues, including sustainability, set aside. But that began to change in 2003, when managers of large pension funds were among the representatives of finance attending the first Institutional Investor Summit on Climate Risk at the United Nations. Among those forward-looking institutions were state pension funds from California, Connecticut, Maryland and New York, representing more than $1 trillion in assets. A few months after the Summit, the California Public Employees Retirement System (CalPERS) and the California State Teachers Retirement System (CalSTRS) pledged to put $1.4 billion into green-venture investing.

Yet, the world is full of contradictions, and it is important to note that pension funds are also some of the biggest holders of oil and gas companies. In the U.S., pension funds hold 31.2% of America’s oil and natural gas companies, making them the largest owner of the U.S. fossil fuel sector.

In Australia, as reported in Financial Institutions taking Action on Climate Change, the Local Government Super Scheme (a superannuation fund) invests around 8 percent of assets in low carbon investments, including equities, property, and green bonds. Pension Danmark, which covers around 11% of Denmark’s population has 9 percent ($3 billion) allocated to low carbon investments, including grid infrastructure, and is expanding its portfolio of renewable energy infrastructure in developing markets, Europe and North America.

Some pension funds not only invest green, they also assess and report on carbon risk, setting an important bar for green investing. The Pensions Trust, a pension scheme for charities and voluntary organizations in the UK, requires its hedge fund managers to report exposure to climate change risk—an unusual demand of hedge funds, which are generally not known for their transparency.

Robert Jay Lifton has dubbed the unfolding psychological shift in thinking about global warming a climate “swerve” , applying terminology originally coined to describe a “major historical change in consciousness that is neither predictable nor orderly.” A similar shift appears to be occurring in the financial markets, and to some extent to be driven by growing awareness of major macro-demographic trends.

The challenge is twofold. First, to get more out of a relatively static pool of natural resources, and second to provide the energy sources, including food, necessary to support contemporary lifestyles for 9.6 billion people by 2050. Moreover, this must be done while controlling greenhouse gas emissions and maintaining the bio-diverse ecosystems necessary to support life.

Are markets responding to these trends less so to “do good” than to do well?

The principal drivers of change are the search for better returns on investment in the long-term, and a desire to manage risks by lessening exposure to fossil fuel companies (which could become “stranded assets”) or by diversifying away from the traditional bonds/equities mix to hedge better against market volatility. Chen describes the drivers of green investing as being “rooted in economics, risk, value, opportunity.”

“There’s nothing soft about this,” he says.

The jury is out.

A 2012 study from Deutsche Bank found that companies with high performance ratings in environmental, social and governance (ESG) criteria outperformed their industry peers. Another study spanning nearly 20 years (1993-2011) from the Harvard Business School found that 90 companies with strong sustainability policy and practices outperformed firms with low standards, with a 4.8% difference in return. A report by Australia’s Responsible Investment Association found that funds designed to meet criteria for ethics, environmental sustainability and social responsibility – known as core responsibility funds – outperformed most fund classes in 2013.

On the other hand, “[T]here exists a perception in the market that green investments are performing poorly. Reasons cited for this include the fact that green equity indices have underperformed the market average (such as the S&P500) recently, high profile renewable energy manufacturing companies have been in financial trouble… regulatory support has been reduced or remains very uncertain in many markets, and venture capital firms have not been as successful as expected in the clean-technology industry,” writes Christopher Kaminker for the OECD in “Institutional Investors and Green Infrastructure Investments: Selected Case Studies.”

Perceptions certainly shape reality, but in the longer run the financial community needs common standards as to what constitutes “green” or “sustainable;” hard analytic tools to comprehensively assess the performance of green investments; and national and global policies that support the development of a low-carbon economy.

Green bonds are bonds tied to environmentally friendly investments. Issuers of green bonds raise money, promising to spend it on projects which could provide climate adaptation, climate mitigation, lower emission. The sector is growing fast. In 2013, most green bonds were sold by international bodies such as the World Bank. But now half are issued by companies.
They debuted in 2007, when the European Investment Bank issued the first climate bond of its kind. Then, in 2008, the World Bank issued green bonds to stimulate and coordinate public and private sector activity around climate change. Since then the Bank has raised more than $6.7 billion via 72 green bonds in 17 currencies.

Institutional investors have shown more interest in recent years, notably since 2013, when the International Finance Corporation issued two $1 billion green bonds. Over $25 billion in green bonds have been issued so far this year. In the last two years, corporations such as Toyota, Unilever and the global utility GDF Suez have also entered the fray.

But some point to a lack of clear standards as an obstacle to progress. Bond issuers have taken some steps to set standards and clarify the shades of green in green bonds, but these are still voluntary in character and not universally applied.

In 2014 JPMorgan Chase, Bank of America Merrill Lynch, Citi, and Credit Agricole Corporate and Investment Bank released a voluntary set of guidelines called the Green Bond Principles, which have been endorsed by thirteen major financial institutions.

Although future projections are upbeat, for example the Climate Bonds Initiative expects $100 billion in green bonds to be issued in 2015, green bonds still only account for a fraction of the overall bond market with its estimated $100 trillion in outstanding loans.

Every day brings reports of new sustainable investments and initiatives: whether in green bonds, clean energy, energy efficiency, climate-smart agriculture, or other related investments. But the blizzard of good news can obscure a bigger picture. Are we anywhere near a tipping point when it comes to sustainable investing?

As the UNEP’s Finance Initiative says, “Every year, investment in unsustainable financial products and services continues to outsize cash flows directed towards the budding—and yet profitable—sustainable economy.”

In the words of Mikhisa Kituyi, Secretary General of the United Nations Conference on Trade and Development (UNCTAD): “At present, the financial markets are not hard-wired to drive capital towards sustainable business. This can and should change.”