In the decade since the launch of the Principles for Responsible Investment (PRI), responsible investment has entered the mainstream. This document introduces some of the discipline’s main concepts and methodologies.
Why invest responsibly
Responsible investment is a strategy and practice of incorporating environmental, social and governance (ESG) factors in investment decisions. Examples of ESG factors include:
- environmental – climate change, water, resource scarcity, waste, biodiversity, etc.
- social – employee engagement, health and safety, worker and human rights, local communities, diversity, etc.
- governance – independent oversight, management systems, shareholder rights, remuneration etc.
This document introduces some of the discipline’s main concepts and methodologies, with selected examples of further resources provided throughout. Be sure to explore the rest of the PRI website to discover the full range of guides, case studies, videos, events and other services that the PRI offers.
The link to financial performance
Responsible investment aims to align with an asset owner’s main objectives. While for some asset owners, values – or an objective to create positive real-world – may be a primary focus, responsible investment generally is aimed at enhancing performance and achieving market-rate or better returns.
“Only 10% of studies display a negative ESG-CFP relationship, with an overwhelming share of positive results.”
ESG & Corporate Financial Performance: Mapping the global landscape
When Deutsche Asset Management and the University of Hamburg analysed the more than 2,000 academic studies (and 60 meta studies) on how ESG factors affect corporate financial performance, they found “an overwhelming share of positive results” and just one in ten showing a negative relationship.
A 21st century approach to fiduciary duty
As it is increasingly recognised that ESG issues are often financially material in the short- and long-term, they are an important part of investors’ approach to fulfilling their fiduciary duty to beneficiaries. The PRI’s Fiduciary duty in the 21st century programme, examining fiduciary duty and other investor obligations around the world, has found that far from fiduciary duty being a barrier to considering ESG issues, investors’ legal obligation towards beneficiaries can be a key reason to embed sustainability considerations in their investment decisions. This is being reflected by a growing number of policy makers and regulators worldwide.
How to embed responsible investment in the investment process
To effectively include ESG factors in investment decisions and active ownership, such approaches must be firmly embedded in the entire investment process. Stages may include:
- Mission, vision and statement of organisational purpose
- Investment strategy
- Investment policy
- Integrated responsible investment policy
- Separate responsible investment policy
- Strategic asset allocation
- Mandate development per asset class
- In-house versus external management
- In-house: portfolio construction and investment selection
- External: selection, appointment and monitoring
- Active ownership (voting, engagement and litigation)
Responsible investment methodologies
Responsible investment is a broad concept. There are no fixed rules about how an investor must include ESG factors in investment decision-making, and the PRI does not have or promote a preferred methodology.
The PRI broadly groups the variety of approaches available into ESG incorporation (comprising integration, screening and thematic investment) and active ownership. Alongside these sit options to act outside of the portfolio to influence the markets in which investors operate, such by engaging public policy makers.
It is up to individual asset owners to interpret their fiduciary duty and choose which methodology (or combination of methodologies) best fits their objectives.
Responsible investment methodologies to consider include:
- exclusion or norms-based screening
- negative screening
- positive or best-in-class screening
- fundamental integration
- factor investing
- ESG tilts
- thematic investing
- impact investing
- responsible investment in passive or ruled-based investing
- three-dimensional investing
- active ownership (voting, engagement, litigation)
- public policy engagement
Reporting and assessment
Transparency throughout the investment chain is key; just as it is important that companies and other invested entities report on their management of environmental, social and governance issues in their operations, investors must monitor and report on their responsible investment activities.
PRI signatories do this through PRI reporting, the largest global reporting project on responsible investment.
Support from the PRI
Although this paper outlines the basics of responsible investment, an asset owner that has just embarked on this journey may need additional guidance on how to implement responsible investment across its strategy, organisation and investment practices.
If you would like more information on responsible investment, including how to become a signatory, please contact us.
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