RI Explained

Good investors have long known that there is more that drives investment returns that just what is reported in financial reports.

 

Responsible investors all understand that companies or assets won’t thrive whilst ignoring environmental issues (pollution, climate change, water and other resources scarcity), social issues (local communities, employees, health and safety), corporate governance issues (prudent management, business ethics, strong boards, appropriate executive pay) or ethical issues.

 

In formal terms, responsible investment is a process that takes into account environmental, social, governance (ESG) and ethical issues into the investment process of research, analysis, selection and monitoring of investments.

 

There is a broad array of methods that responsible investors use to manage these non-financial risks – from excluding companies involved in controversial industries, to supporting the most sustainable companies, to a sharp focus on ESG risks, and using ownership to engage with companies.

 

This diversity of approach is a plus for the public who can find an option that matches your own values, concerns, risk profile and life stage.

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Responsible Investment Approaches

The responsible investment sector is one of huge diversity, whereby a plethora of investment approaches are used, all in addition to fundamental financial analysis. Increasingly, investors are using a combination of approaches listed below.

 

We now have fund managers and super funds who apply environmental, social and governance integration, screen companies (e.g. tobacco), use sustainability themed investments (e.g. clean energy funds and green property), engaging actively with companies and making impact investments whilst also generating strong financial results.

  • Exclusionary/negative screening systematically excludes industry sectors, companies, practices or even, at times, countries based on specific ESG or ethical criteria from a fund or portfolio. This approach is also often referred to as values-based or ethical screening. Common criteria used in negative screening include gaming, alcohol, tobacco, weapons, pornography and animal testing.

 

  • Positive/best-in-class screening is investment in sectors, companies or projects selected for positive ESG or sustainability performance relative to industry peers. Best-in-class screening involves identifying those companies with superior ESG performance from across all sectors, and does not exclude companies or activities based on ESG or ethical grounds.

 

  • Norms-based screening screens investments against minimum standards of business practice based on international norms such as those defined by the United Nations (UN). This can include, for example, excluding companies that would contravene the UN Convention on Cluster Munitions, and/or screening primarily based on ESG criteria developed through international bodies such as the United Nations Global Compact, International Labour Organisation, UNICEF (United Nations Children’s Fund) or the UNHRC (United Nations Human Rights Council).

Focuses on investment in themes or assets specifically related to sustainability factors. This commonly refers to funds that invest in clean energy, green technology, sustainable agriculture and forestry, green property, or water technology.

These include targeted investments aimed at solving social or environmental problems whilst also delivering financial returns. Impact investing includes community investing, where capital is specifically directed to traditionally underserved individuals or communities, or financing that is provided to businesses with a clear social purpose. 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.

This strategy employs shareholder power to influence corporate behaviour including through direct corporate engagement (i.e. communicating with senior management and/or boards of companies), filing or co-filing shareholder proposals and proxy voting that is guided by comprehensive ESG guidelines. Investor activism on governance issues has grown substantially in the last ten years, particularly in Britain and the United States, and especially in relation to director elections and remuneration. More recently, environmental and social resolutions have also grown in number and support.

Constituting the largest category of responsible investment in terms of funds under management, ESG integration involves the systematic and explicit inclusion of environmental, social and governance factors into traditional financial analysis and investment decision making.  This is based on an acceptance that these factors represent a core driver of both value and risk in companies and assets. ESG knowledge and data 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.