The terminology used in relation to Responsible Investing can be confusing. For example, often the terminology Responsible Investing gets confused by some to mean exclusively Ethical Investing or Social Responsible Investing (SRI). Both of which have been shown to deliver below market returns. They are separate activities along the Responsible Investing continuum.
At an institutional Funds Management level Responsible Investing (RI) has been associated with the United Nations Principles of Responsible Investing (PRI). PRI has six principles, see below.
Often sector/stock exclusions are implemented and/or an overlay or integration of taking into consideration Environmental, Social and Environmental (ESG) criteria is employed.
This approach to RI has been around for some time, particularly in Europe and Australia.
It is now well established that considering or integrating ESG information leads to better-informed investment decisions.
However, the Sustainable Development Goals (SDG) are an important recent development. The SDG are a collection of 17 global goals set by the United Nations General Assembly in 2015 for the year 2030.
The SDG take Responsible Investing, sustainability, to the next level by making it more tangible and measurable.
As a result, there is a growing and important change in the approach toward RI, from just avoiding those companies with a negative impact on the environment to investing in companies that have a positive way.
Therefore, SDG have impacted RI in a couple of important ways:
- The RI continuum has become more defined with the increased focus on Impact Investing. As presented in the Table below, the RI continuum moves from “Financial Only” to “Impact Only”
- Industry terminology is moving on from RI to Sustainable Investing.
The Continuum of “Responsible Investing”
|Financial Only||Limited or no regard for environmental, social or governance practices|
|Responsible (ESG)||Mitigate risky environmental, social or governance practices in order to protect value|
|Sustainable||Adopt progressive environmental, social or governance practices that may enhance value|
|Address societal challenges that generate competitive financial returns for investors|
Likely below market Returns
Address societal challenges which may generate a below-market financial return for investors
Require below Market Returns
|Address societal challenges that require a below market financial return for investors|
|Impact Only||Address societal challenges that cannot generate financial return for investors|
The information in the above Table is sourced from: Lessons from Social Impact Investment Taskforce: Asset Allocation Working Group, 12 December 2014.
Using the Table above, the RI continuum starts at “Financial Only” considerations and ends at “Impact Only” considerations. Using this continuum the following observations can be made in relation to the objective(s) each RI category is focusing on achieving, there is an overlapping nature:
- Generating competitive financial returns are an object starting from Financial Only and persisting to Impact (b).
- The objective of mitigating Environmental, social and governance risks starts from Responsible (ESG) and continues right through to Impact Only
- The Pursuit of environmental, social, and governance “opportunities” starts at Sustainable and is maintained through to Impact Only
- The goal of focusing on measureable high-impact solution obvious begins with Impact (a) and until Impact Only.
Therefore, as mentioned, RI is increasingly encompassing sustainability. Sustainable Investing.
The UN-backed Principles for Responsible Investment explains sustainability investing as follows: “We believe that an economically efficient, sustainable global financial system is a necessity for long-term value creation. Such a system will reward long-term, responsible investment and benefit the environment and society as a whole.”
Fund managers, such as RobecoSAM, would use the term sustainability investing to mean “the pursuit of superior financial returns coupled with positive environmental, social and corporate governance outcomes”.
Sustainable Investing can be thought of as having three main components:
Using ESG information to improve the risk and return profile.
Avoiding investment in areas of controversial products or business practices.
Investing for socioeconomic impact alongside the financial returns.
Each of these components could be done in isolation or in combination with each other.
Increasingly best practice is incorporating all three components into the investment process and implementing across a variety of asset classes i.e. not just equities.
Furthermore, while exclusions adopt a negative approach, increasingly the ESG research is being applied in a positive way i.e. investing in companies with the best ESG practices rather than just avoiding those with the worst practices.
Overtime, I hope to cover off each of the Sustainable Investing components outlined above in separate posts and will provide links.
I will leave the final thoughts to RobecoSam, where they quite rightly draw the link between sustainable investing and delivering competitive financial returns from investing.
Finance has a role to play!
“Financial materiality is the critical link at the intersection of sustainability and business performance. More specifically, investors should focus on identifying the most important intangible factors (sustainability factors) that relate to companies’ ability to create long-term value. For instance, lowering energy consumption in manufacturing processes results in significant cost-saving opportunities and has a direct impact on a company’s bottom line. Going a bit deeper, financial materiality is defined as any intangible factor that can have an impact on a company’s core business values. These are the critical competencies that produce growth, profitability, capital efficiency and risk exposure. In addition, financial materiality includes other economic, social and environmental factors such as a company’s ability to innovate, attract and retain talent, or anticipate regulatory changes.
These matters to investor because they can have significant impacts on a company’s competitive position and long-term financial performance. “
These sentiments were echoed in a recent FT article.
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Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.
Principle 1: We will incorporate ESG issues into investment analysis and decision-making processes.
Principle 2: We will be active owners and incorporate ESG issues into our ownership policies and practices.
Principle 3: We will seek appropriate disclosure on ESG issues by the entities in which we invest.
Principle 4: We will promote acceptance and implementation of the Principles within the investment industry.
Principle 5: We will work together to enhance our effectiveness in implementing the Principles.
Principle 6: We will each report on our activities and progress towards implementing the Principles.