Responsible Investment Explained

The ongoing consideration of ESG factors within an investment analysis and decision-making process with the aim to improve risk-adjusted returns.

This approach is based on the beliefs that ESG factors can affect the risk and return of investments and that ESG factors are not fully reflected in asset prices. ESG integration involves seeking out ESG information, assessing the materiality of that information, and integrating information judged to be material into investment analysis and decisions. The details of implementation can vary.

An ESG factor is any qualitative or quantitative information pertaining to environmental, social, or governance topics.

Information includes but is not limited to raw data, statistics, estimates, assessments, analyses, rankings, and scores.

ESG integration is an ongoing part of the investment process, not a one-time activity. Consideration of ESG factors does not imply

• that there are restrictions on the investment universe,
• that ESG factors are given more or less consideration than other types of factors,
• that all ESG factors are given equal consideration, or
• that the resulting portfolio will have any particular characteristics.

The term “Consideration” (1) more precisely reflects the nature of ESG integration, (2) helps distinguish ESG integration from other ESG investment approaches, and (3) helps prevent other ESG investment approaches from being characterised as ESG integration.

A process for determining which investments are or are not permitted in a portfolio by applying rules based on defined criteria.

Screening rules can be set by clients, chief investment officers, regulators, and others. Because screening rules prescribe whether an investment is permitted in a portfolio, screening is often subject to compliance oversight. Screening rules can be qualitative or quantitative and may incorporate implementation requirements.

For example, they may stipulate the timing or conditions for selling any investments that cease to meet the screening criteria.

Screening criteria can be based on various investment characteristics, including environmental, social, and governance (ESG) characteristics.

For example:

• Whether a sovereign issuer achieves a given human rights performance score (e.g., 40 out of 100) from a specific ratings provider
• Whether =10% of an issuer’s revenue is from the production and/or sale of tobacco products

Thresholds are an essential element of any quantitative screening criteria. Thresholds can be absolute, relative, or relative to peers.

For example, a Scope 1 carbon dioxide emissions screen threshold may be

• carbon neutrality (absolute threshold),
• 200 tons per USD1 million revenue (relative threshold), or
• the industry average carbon intensity (relative to peers threshold).

Screening rules categorically determine whether individual investments are permissible in a portfolio. They do not apply to the aggregate portfolio.

For example, a screen using governance scores would stipulate the necessary governance score of each investment, not the average governance of the investments in a portfolio.

Common types of ESG screening:

Exclusionary Screening/ Exclusions

1. Applies rules
2. Based on ESG criteria
3. That determine whether an investment is not permitted

Negative Screening

1. Applies rules
2. Based on “undesirable” ESG criteria
3. That determine whether an investment is not permitted

Positive Screening

1. Applies rules
2. Based on “desirable” ESG criteria
3. That determine whether an investment is permitted

Best-in-Class Screening:

1. Applies rules
2. Based on ESG criteria that are “desirable” relative to peers
3. That determine whether an investment is permitted

Norms-Based Screening

1. Applies rules
2. Based on Compliance with widely recognised ESG standards or norms
3. That determine whether an investment is or is not permitted

Constructing a portfolio of assets, chosen via a top-down process, to access benefits from specific medium- to long-term trends. Thematic investing is underpinned by the belief that economic, technological, demographic, cultural, political, environmental, social, and regulatory dynamics are key drivers of investment risk and return.

Thematic investing enables investors to increase their investment exposure to a trend. A portfolio of assets selected for their connection to a trend will often have a risk–return profile that is different from a broad market index.

Some investors use thematic investing to access specific trends:

• they believe will shape the medium- to long-term trajectory of the economy and result in higher investment returns’
• to diversify their portfolio or hedge against specified economic risks; and/or
• to increase their association and involvement with a trend.

The focus is on forecasted trends and assets relevant to the trends. Trends tend to be medium to long term in duration, regional or global in scope, and cross-cutting with respect to traditional industry or sector boundaries. For example: climate change and the shift to a more circular economy. Thematic investing can be focused on a single trend or several related trends.

For example, a thematic investor might simultaneously seek to gain exposure to assets that will benefit from an ageing population, increasing urbanisation, and population growth trends.

Thematic investing (selecting assets to access specified trends) is not the same as a “thematic fund” (portfolio that is focused on a particular interest or area) – while thematic investment may often result in a focused portfolio, all focused portfolios are not the result of thematic investing.

For example, investors may wish to invest in a portfolio of veteran-owned businesses because they want to support veterans while earning a financial return. However, this would not constitute thematic investing unless a case is made for how veteran-owned businesses enable access to a specified trend or trends.

The deliberate deployment of rights and influence (beyond capital allocation) to protect and enhance overall long-term value for clients and beneficiaries, including the common economic, social, and environmental assets on which their interests depend.

As shareholders, lenders, and owners of real assets, investors have legal rights and other means of influencing the behavior of investees and other parties, such as policymakers. The ability to exercise influence spans asset classes, although the means to do so vary depending on the context.

Examples of ways in which investors can exercise their rights and influence include the following:

• Serving on or nominating directors to a company’s board
• Filing shareholder resolutions or statements
• Voting on proposals at shareholder meetings
• Engaging with investees and potential investees
• Litigating
• Providing input into industry research, market standards, public discourse, or policy and lawmaking
• Actively participating in third-party or collective initiatives that undertake any of the above

The concept of overall value for clients and beneficiaries is multifaceted. It includes the market value of the entire portfolio (as opposed to individual holdings or individual mandates); the long-term value-creation capabilities of firms and economies; and the common environmental, natural, intellectual, social, and institutional assets that underpin all economies.

Examples of environmental assets include a stable climate, or an aquifer’s freshwater resource.

Examples of social assets include a population’s health, skills, and economic participation and institutions that undertake research and development for the public good.

Investor influence does not constitute stewardship unless it is used to protect and enhance overall long-term value for clients and beneficiaries. Using influence to promote short-term performance or the performance of individual companies, industries, or markets, without regard to overall value, does not constitute stewardship.

Investing with the intention to generate positive, measurable social and/or environmental impact alongside a financial return. Impact investing aims to contribute to or catalyse positive effects (e.g., improvements in people’s lives and the environment) while achieving a financial return. Impact investing can be pursued across a range of asset classes, including fixed income, real assets, private equity, and listed equity investments. It is different to philanthropy in that it pursues a financial return in addition to a positive, measurable impact. Impact investors have discretion over the rate of return they target.

Impact investing pursues two distinct objectives:

(1) an improvement in social and/or environmental conditions and

(2) a financial return on capital invested.

Impact investing requires a “theory of change”—that is, a credible explanation of the investor’s contributory and/or catalytic role, as distinct from the investee’s impact. Impact investing aims to contribute to or catalyse real-world environmental and/or social improvements, by providing necessary financing and/or by gaining access to other mechanisms of investor influence.

Impact investing requires accounting for whether—and to what extent—intended environmental or social improvements actually occur.

Examples of metrics used to track positive impact include the following:

• Renewable electricity capacity added (MWh)
• An increase in water treated, saved, or provided (megaliters)
• An increase in affordable housing units (number of units).