What is responsible investing?
Human rights abuses; pollution emissions; gender diversity; alcohol and gambling.
These are just some of the things you might need to think about if you are trying to invest responsibly.
But responsible investing is one of those terms that gets used a lot – but maybe is not properly understood. Responsible investing is not about making a judgement as such on whether an investment is good or evil. It’s about getting the full picture of how a company runs its business.
When you have researched your investment choices and have a clear understanding of what the investment will fund, you are investing responsibly. It is also known as sustainable investing and ethical investing.
When you invest responsibly in a listed company, you undertake a detailed analysis of all the aspects of business so that you know as much as you can before making a decision to invest.
Usually investment selection process will screen companies based purely on financial criteria, such as leverage metrics and valuation ratios and possibly some analysis of company executive, management and culture.
A responsible investment process will, in addition, identify environmental, social, governance or ethical factors.
Regardless of the investment process, the objective of achieving a competitive financial return is maintained.
Responsible Investment Screening
During the research, analysis, selection and monitoring of an investment in the Responsible investment selection process, a procedure called screening is applied.
Screening can be:
- Applied to select investments based upon relative performance on specific issues (such as carbon emission benchmarks or governance standards)
- Applied to exclude entire sectors or activities (such as gambling or those who abuse human rights)
- Used for equities as well as property, fixed income and infrastructure
- Employed either before or after the financial analysis has taken place
- Supported by a pre-determined methodology that is clearly defined and transparent
The competitive performance of screened investments depends on both the screening methodology and the final portfolio construction, which fall into one of two categories:
- Negative screening – the exclusion or avoidance of an investment based upon environmental, social, governance or ethical factors
- Positive screening – favorable consideration of an investment opportunity based upon the same issues
There are six responsible investment styles that can be applied to any selection process:
1. Best of Sector
This investment style implies that all industries should adopt higher standards of ethical, social and governance practices (ESG) in order to meet the expectations of society and to achieve sustainable and profitable business goals. This process does not involve negative screening, but rather identifies those companies with superior ESG performance from across all sectors.
2. Thematic Investment
Portfolios that only contain investments that positively impact a particular sustainability theme such as environmental technology, carbon intensity, sustainable agriculture and forestry, water technology, waste management, community investing, affordable housing, sustainable property and infrastructure, human rights, microfinance or governance. This category also includes multi-strategy portfolios, which may contain a variety of asset classes or a combination of these themes.
3. Impact Investing
This emerging investment style involves actively placing capital in businesses and funds that are directed toward solving specific and significant environmental and social challenges, while providing returns to the investor that range from principal to above market.
Investors usually include high net wealth individuals, institutional investors, charities, corporations and foundations, who invest across a wide range of asset classes and where success is measured by a combination of financial returns and environmental and social impact.
4. Ethical, Social and Governance integration
The incorporation of ESG factors into the investment decision-making process. More specifically, ESG knowledge is used to inform the analysis of risk, innovation, operating performance, competitive and strategic positioning, quality of management, corporate culture and governance and to enhance financial valuation, portfolio construction, engagement and voting practices.
5. Engagement with companies on Ethical, Social and Governance issues
This is when an asset manager, asset owner or specialist firm will contact companies to build the business case for better management of ESG issues. Engagement may involve the formal or informal collaboration with like minded investors on common issues which can increase the likelihood of a positive outcome from the engagement process.
6. Shareholder activism – voting and resolutions
Investors who are active owners will exercise their right to vote and their right to raise resolutions in order to achieve better management outcomes.
Why Invest Responsibly?
The aim of responsible investing is to generate competitive returns and find sustainable solutions to challenges that face our communities. The following are five common reasons to use responsible investing techniques when you are designing your portfolio:
1. Competitive and Sustainable Returns – Responsible investing delivers a sound investment strategy, competitive returns and your money is invested in line with your values.
2. Help the causes that are relevant to you – If you care about a cause such as environment and climate change or diversity in the workforce, responsible investment is a powerful way to make a difference.
3. Hold companies accountable – Responsible investors can demand greater accountability from companies on important ethical and governance issues and their environmental and social practices.
4. Put your money where your mouth is – If you find yourself talking about environmental, social and ethical issues that you are passionate about, why not invest your money in line with these causes?
5. There’s something for everyone – There is a broad range of products available, carefully designed to suit different financial goals, personal values and interests.