What is sustainable investing?
People. Planet. Profit.
Businesses risk huge damage to their brands and reputations if they fail to be good global citizens.
A company with a poor environmental record could be hit by fines or sanctions. A business that has poor labour relations is more likely to suffer from low productivity and face costly industrial action.
Fines, legal action, regulation, or negative press can ultimately harm their long-term returns.
On the other hand, companies that show they care about the environment, are forward-thinking on social factors (such as diversity or human rights) and follow good governance structures are more likely to perform better in the long run.
We live in an age of protests and marches. But increasing numbers of investors are finding there’s greater leverage in how they deploy their capital. They want to reward those companies that are practising responsible capitalism – and avoid the ones that don’t.
ESG — The Core of Sustainable Investing
At the heart of any sustainable investment is a focus on environmental, social and governance factors, known as ESG.
Environment
Climate change
Water scarcity
Pollution
Biodiversity
Resource management
Social
Human rights
Equality and diversity
Labour standards
Data protection and privacy
Community relations
Governance
Board composition
Shareholder rights
Bribery and corruption
Executive compensation
Accounting and audit standards
How It Works
Approaches to ESG vary between managers. Some score companies according to ESG metrics and ratings, others focus on influencing corporations via active engagement and voting. Here is a summary of the main types of ESG investing:
Impact investing
Investments made to generate positive, measurable social and environmental impact alongside a financial return. Usually driven by investing in specific themes (for example, such as targeting businesses that tackle water scarcity).
Positive screening
Inclusion-based investing. Targets companies exceeding ESG criteria. Ratings are based on specific areas, such as climate change or human rights, or more general targets (such as the UN Sustainable Development Goals.)
Negative screening
‘Exclusion-based investing’. Avoids companies that don’t reach minimum criteria in ESG ratings. Common examples include screening out weapons manufacturers, tobacco companies, firms using palm oil in their products, or thermal oil producers.
Integration
Incorporating analysis of financially relevant ESG analysis into investment decisions, financial modelling, and portfolio construction. It does not mean barring investments in particular sectors, countries, or companies.
At Better World Financial Planning, we use model portfolios from investment managers who have built strong track records, each with their own criteria for assessing sustainable investments.
Separating Fact from Fiction — 3 ESG myths
Despite the growing popularity of sustainability investing, there are still many myths about what it means.
“ESG and responsible investing are a bit of a niche concern”
Research shows that interest in ESG investing is growing rapidly. Record amounts of capital has been invested in ESG-themed funds in recent years. This trend is also likely to grow even more rapidly, with rules for financial advisers under MiFID II (European financial regulations) making it mandatory for firms to include questions on ESG investing as part of the suitability process with clients.
Think this is something that only applies to ‘millennials’? It’s not. Studies show there is interest across a range of ages, as more people see the potential value their financial decisions can have on the world around them.
“I can’t afford to compromise my pension savings”
Not only can ESG-based investments match the performance of funds with a wider focus, there’s also growing evidence that they can do even better. Research has shown that companies with improving ESG credentials have outperformed those with low-ESG credentials over the long term.
“One investor can’t change anything”
Investing in pooled vehicles with an ESG focus allows individual investors to put their money behind the causes that matter to them. Shareholders are demanding companies take their sustainability responsibilities seriously when they vote in annual general meetings and businesses are having to take note.
In the UK, high-profile campaigning for better provision of free school meals led to investors asking demanding questions of the public company responsible. Meanwhile, global news stories, such as oil spills, or the EU vehicles emissions scandal, mean companies know their share price is dependent on being better global citizens.
Glossary
There are many buzzwords and technical terms associated with ESG and sustainable investing:
SRI (Socially Responsible Investing)
These funds build a portfolio of above-average ESG quality using a combination of positive and negative screening.
Ethical investing
This usually refers to funds which exclude profiting from activities considered harmful to society or the environment, while investing in companies committed to a sustainable future.
Stewardship (or active ownership)
Shareholders taking an active role in the long-term success of a business, with the aim of benefiting the company, investors, and the wider economy. They do this through engagement and voting in shareholder meetings (such as AGMs).
Engagement and proxy voting
Investors engage with public companies to leverage their position as shareholders and influence corporate decision making. They do this by voting on proposals and resolutions at AGMs or collaborate with companies to point them to best practice.
UN Sustainability Development Goals
17 interlinked global goals designed as a blueprint for a more sustainable future. They include “zero hunger”, “no poverty”, “gender equality” and “good health and wellbeing”. The SDGs underpin many, if not all, ESG strategies and policies. For more information visit here.
Principles of Responsible Investment (PRI)
A UN-supported network of investors advocating responsible investment. Promotes collective engagement with companies to benefit the environment and society.
Paris agreement
A key date in the global efforts to address climate change, referring to the United Nations Framework Convention on Climate Change held in December 2015. The legally binding international treaty signed in April 2016, aims to limit global warming to well below 2 degrees Celsius compared with pre-industrial levels.
Stranded assets
A key concern in sustainable investing. Assets which have to be written down prematurely by companies, for example due to new regulations or changing social attitudes (such as fossil fuel divestment).
ESG ratings
Methodologies put in place by analysts and ratings agencies to quantify company’s resilience to ESG risks.