Responsible investment is an approach to investing that aims to incorporate environmental, social and governance (ESG) factors into investment decisions, to better manage risk and generate sustainable, long-term returns.
Why invest responsibly?
The global momentum around responsible investment is driven by:
- recognition in the financial community that ESG factors play a material role in determining risk and return;
- understanding that incorporating ESG factors is part of investors’ fiduciary duty to their clients and beneficiaries;
- concern about the impact of short-termism on company performance, investment returns and market behaviour;
- legal requirements protecting the long-term interests of beneficiaries and the wider financial system;
- pressure from competitors seeking to differentiate themselves by offering responsible investment services as a competitive advantage;
- beneficiaries becoming increasingly active and demanding transparency about where and how their money is being invested;
- value-destroying reputational risk from issues such as climate change, pollution, working conditions, employee diversity, corruption and aggressive tax strategies in a world of globalisation and social media.
What are environmental, social and governance (ESG) factors?
Examples of environmental, social and governance (ESG) factors are numerous and ever-shifting. They include:
- climate change – including physical risk and transition risk
- resource depletion, including water
- waste and pollution
- working conditions, including slavery and child labour
- local communities, including indigenous communities
- health and safety
- employee relations and diversity
- executive pay
- bribery and corruption
- political lobbying and donations
- board diversity and structure
- tax strategy
Is responsible investment the same socially responsible investment (SRI) or impact investing?
In touching on themes including environmental issues, social issues and sustainability, responsible investment does have similarities with such investment approaches as:
- socially responsible investing (SRI)
- impact investing
- sustainable investment
- ethical investment
- green investment
Crucially, however, while these approaches seek to combine financial return with a moral or ethical return, responsible investment can and should be pursued even by the investor whose sole purpose is financial return, because it argues that to ignore ESG factors is to ignore risks and opportunities that have a material effect on the returns delivered to clients and beneficiaries.
Also, many of these investment approaches target specific themes, such as focusing solely on environmental issues, whereas responsible investment is a holistic approach that aims to include any information that could be material to investment performance.
Is responsible investment about screening and divestment?
Responsible investment does not require ruling out investment in any sector or company. It simply involves including ESG information in investment decision-making, to ensure that all relevant factors are accounted for when assessing risk and return.
Exactly how an investor practices responsible investment varies widely. It can include:
- integrating ESG information into quantitative and qualitative analysis (such as fundamental analysis of company value in equity investing or assessment of creditworthiness in fixed income investing), which could result in making adjustments to areas such as selection, weighting or asset allocation;
- engaging – either individually or alongside other investors – with investee companies/entities on the ESG factors identified as relevant to them;
- using shareholder voting rights to influence company behaviour;
- encouraging investee companies/entities to disclose information on the ESG factors that do or could affect them;
- monitoring overall ESG risk within the portfolio, for instance by measuring the portfolio’s carbon footprint;
- contributing to the shaping of investor-relevant public policy;
- promoting wider acceptance and use of responsible investment within the investment industry.
Does practising responsible investment mean using themed funds and green bonds?
Responsible investment does not require the use of specialised products. It is primarily about bringing additional data and analysis into existing approaches. Tailored products whose remit overlaps with areas responsible investment do exist, such as environmentally- or socially-themed funds, green bonds or social impact bonds, and these can form part of a responsible investment strategy.