Responsible Investment Explained

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

 

They 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.

 

Responsible investment, also known as sustainable or ethical investment, is a broad-based approach to investing which factors in people, society and the environment, along with financial performance, when making and managing investments.

 

Examples of responsible investing vary broadly and could include:

– divesting from a company with a poor human rights record

– engaging with a company included in an investment portfolio around its exposure to carbon intensive industries

– making an investment in a program or social enterprise that is focused on tackling a pressing social or environmental issue

– analysing and selecting a portfolio of companies to invest in based on their overall environmental, social and governance performance

 

Investors engage in responsible investing for a range of reasons including: to align investments with their own or their clients’ personal values and ethics; to reduce risk; and to achieve strong financial returns in the short and long term.  All kinds of investors can be responsible investors, whether they are individuals choosing where to put their savings or superannuation; a trustee of a trust or foundation; or an institutional investor such as a super fund, fund manager, bank or asset manager.

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. Investors typically use a combination of approaches listed below.

ESG integration
ESG integration: the systematic and explicit inclusion by investment managers of environmental, social and governance factors into the investment decision-making process.
Negative/exclusionary screening
Negative/exclusionary screening: the exclusion from a fund or portfolio of certain sectors, companies or practices based on specific ESG criteria, such as what goods and services a company produces, or how inadequate a company or country response is to emergent risks such as climate change impacts.
Minimum-standards (norms-based) screening
Minimum-standards (norms-based) screening: screening of investments against minimum standards of business or government practice, for example as based on international norms such as those issued by the UN, ILO, OECD and NGOs (e.g. Transparency International) and may include exclusions of investments that are not in compliance with norms or standards or over and underweight.
Corporate engagement and shareholder action
Corporate engagement and shareholder action: employing 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.
Positive/best in class screening
Positive/inclusionary screening: intentionally tilting a proportion of an investment portfolio towards positive solutions, or targeting companies or industries assessed to have better ESG performance relative to benchmarks or peers
Sustainability themed investing
Sustainability themed investing: investment in themes or assets and programs specifically related to improving social and environmental sustainability (e.g. safe and accessible water, sustainable agriculture, green buildings, lower carbon tilted portfolio, community programs).
Impact investing
Impact investing: investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return.

Responsible and Ethical Investment Spectrum

RIAA’s Responsible and Ethical Investment Spectrum maps out the various approaches to responsible investing, their similarities, differences and areas of focus.

 

For example, while some responsible investment approaches are oriented around managing environmental, social and governance (ESG) risks, other approaches focus more on pursuing ESG opportunities.  While most responsible investments will target market-rate financial returns, some impact investments will intentionally deliver below market-rate returns in order to maximise the social or environmental impact. The Spectrum also highlights the intentionality that different responsible investment strategies demonstrate towards ‘impact’ such as whether they focus on avoiding harm to society and the environment, or actively contribute to positive solutions for underserved people or the planet.

 

Please note that this Spectrum is only intended as a guide to understanding different responsible investment approaches and their features and that the boundaries defining each strategy are not set in stone, open to varying definitions, interpretations and executions.

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