Sustainable and Responsible Investment
Investment approach that considers environmental, social and governance (ESG) factors in portfolio selection and management
Sustainable and Responsible Investment (”SRI”) is a long-term oriented investment approach, which integrates social, environmental, corporate governance and ethical factors (ESG factors) in the research, analysis and selection process of securities within an investment portfolio. It combines fundamental analysis and engagement with an evaluation of ESG factors in order to better capture long term returns for investors, and to benefit society by influencing the behavior of companies.”(Eurosif definition. See: European SRI study 2016, Eurosif).
Responsible investment has boomed in recent years as investors have recognized the opportunity for better risk-adjusted returns, while at the same time, contributing to important social and environmental issues.
This concept is the basis for several investment approaches with different objectives in their focus, such as:
However, the most general and comprehensive type is Responsible/Sustainable Investing.
As stated in the definition of Principles for Responsible Investment (PRI), it is essential to understand that a key for various approaches (e.g. green investment or mission-related investment, etc.) could be primarily moral or ethical goals, while responsible investing can and should also be pursued by the investors whose sole focus is financial performance.
The idea of responsible investing could be understood as the implementation of corporate responsibilities in investment decisions. It is a strong motivator for the development of the company’s responsibilities and the integration of social and environmental issues into its activities. By doing this, the companies get access to a huge amount of investment capital that is managed according to the responsible investment principles.
Responsible investors are both individual/retail as well as institutional investors. Retail SRI implies to individual investments (for example, personal pension) that are made based on the personal ethical values of specific individuals. There are many funds and united investment mechanisms for small retail investors. Institutional SRI implies to responsible investing by various financial institutions, e.g. pension funds, insurance companies, commercial banks, etc. The number of Institutional SRIs is far higher than that of Retail SRIs.
There are several motivations for sustainable investing, including ethical considerations, moral values, as well as financial goals. In most of the cases this approach combines the investors’ financial goals and public wellbeing objectives, such as social, environmental and ethical ones.
Socially motivated investing has a long history. At the early stages (for example, early 20th century) the approach was motivated only by moral views, when some investors were trying to avoid investing in non-ethical, immoral and unacceptable to them activities (like arms trade, gambling, etc.).
In the modern world, one of the strongest drivers for responsible investment is financial performance and the effectiveness of the investment.
Financial analysts continually mention the advantage of considering the company’s ESG indicators when making investment decisions.
It is believed that consideration of social and environmental issues helps the company in effective risks prevention, improves management systems and establishes good relations with the customers, suppliers, and employees. All these aspects lead to increased work effectiveness and ultimately – to better financial indicators and a better return on the investment.
A number of studies carried out by Oxford University, UNEP FI, Morgan Stanley Institute for Sustainable Investing, and other highly reputable orgaizations have shown that investing in companies with well developed corporate responsibility/sustainability programs and policies is profitable, because, in the long-term, integration of ESG issues into the company operations has a positive impact on the company’s financial performance.
For example, in 2015 and 2018, researchers from Deutsche Asset & Wealth Management Investment and University of Hamburg School of Business, Economics and Social Sciences carried out two joint studies looking at about 2200 empirical studies conducted between 1970-2015 on the relations between companies’ environmental, social, and corporate governance practices (ESG) and their financial performance. Both reports provide remarkably interesting findings: a large majority of the analyzed over 2000 studies show that there is a positive correlation between ESG practices and corporate financial performance, and this positive correlation appears to be long-lasting over the time.
Canadian Association for Responsible Investing - RIA Canada – lists the following results of responsible investing results. (see: https://www.riacanada.ca/responsible-investment/) :
Responsible investment can improve risk management
Responsible investment can enhance long-term financial performance
Responsible investment contributes to a positive societal change
Sustainability Themed Investment / Thematic Investment
Investment in themes or assets linked to the development of sustainability. Thematic funds focus on specific or multiple issues related to ESG. Sustainability themed investments inherently contribute to addressing social and/or environmental challenges such as :
There is a wide spectrum of responsible investment strategies, which investors apply to create their investment portfolios (along with financial analysis). These diverse strategies can be grouped by three general approaches – exclusion, in other words, ruling out investing in morally unacceptable sectors which negatively impact the environment and the mankind (e.g. arms business, gambling business, tobacco industry, etc.); assessment of individual companies and analysis of their activities by social, environmental, ethical and good governance criteria; and influencing the companies behavior and improving their social and environmental performance by means of a dialogue.
Several different strategies focusing on various aspects can fit into these three approaches.
Different organizations offer varying categorization of responsible investment strategies. However, majority of the leading initiatives in the field, such as GSIA, Eurosif, USsif, RIACanada, RIAA, VBDO, PRI, etc. propose similar categorization and set out seven main strategies of responsible investment:
Sustainability Themed Investment / Thematic Investment
Best-in-class Investment Selection / Positive Screening /Best-in-class Screening
Exclusion of holdings from investment universe / Negative screening / Exclusion
Norms-based screening
Integration of ESG issues in Investment Analysis / ESG Integration
Engagement and voting on sustainability matters / Corporate engagement and shareholder action / Active ownership
Impact Investing
In real life, the above mentioned strategies of responsible investing rarely take place only in the so called “pure” form. When building investment portfolio, investors usually combine several strategies (together with carrying out fundamental financial analysis). The approach is known as Aggregation of Strategies.
Sustainable and responsible investing is gradually becoming a global trend and the volume of SRI investments increases steadily worldwide. Over the recent years, socially responsible investment is gaining popularity in developing countries as well (Latin America, Africa and Asia).
Such big volume of assets that are managed by socially responsible investment principles stimulate the companies to revise their policies making their businesses interesting and attractive to this pool of investors.
34% increase from 2016.
Global sustainable investment assets reached $30.7 trillion at the beginning of 2018, 34% increase from 2016.
Global Sustainable Investment Alliance (GSIA), Global Sustainable Investment Review 2018
34% increase from 2016.
Global sustainable investment assets reached $30.7 trillion at the beginning of 2018, 34% increase from 2016.
Global Sustainable Investment Alliance (GSIA), Global Sustainable Investment Review 2018
49% of the overall assets under professional management.
European Union is the largest market for sustainable investment. In 2007, SRI managed assets equaled €2,665 trillion, while by 2018 the volume increased to €12.3 trillion ($14.1 trillion), accounting for 49% of the overall assets under professional management.
Global Sustainable Investment Alliance (GSIA), Global Sustainable Investment Review 2018,
quarter of all professionally managed assets in USA
The US is the second largest center after Europe by the volume of responsible/sustainable investments. In 2018 USD 12 trillion worth of assets in the US were managed by RI principle (making a quarter of all professionally managed assets). From 2016 to 2018, sustainable investing in the US enjoyed a growth rate of more than 38%.
Report on US Sustainable, Responsible and Impact Investing Trends, USsif 2018.
50.6% of total Canadian assets
In Canada, the volume of sustainable and responsible investments is growing steadily. Assets in Canada being managed by a RI strategy equaled to $2.13 trillion in 2018, accounting for more than 50.6% of total Canadian assets under management and showing a 41.6% robust increase as compared from 2016.
In Japan, sustainable investing assets quadrupled in 2016-2018, growing from 3 percent of total professionally managed assets in the country up to 18 percent, and making Japan the third largest center for sustainable investing after Europe and the United States.
Sustainable Investment Alliance (GSIA), Global Sustainable Investment Review 2018,
Australia and New Zealand is the region with the greatest proportion of sustainable investment assets -63% relative to total assets under management.
Sustainable Investment Alliance (GSIA), Global Sustainable Investment Review 2018,
Financial institutions acknowledge that responsible investors need to have commonly agreed principles and investment criteria. With this regard, a number of international or regional standards - the principles of responsible investment that they offer to financial institutions - have been developed. For example, UN Principles for Responsible Investment; Environmental and Social Standards by IFC; Equator Principles; European Code for the Transparency of Socially Responsible Investing; etc.
Social indices / Sustainability indices and ESG ratings rank the businesses by various criteria. Among those, a considerable importance is given to environmental, social and corporate management (ESG) criteria – such as: employee relations, adherence to human rights and to labour standards; transparency and accountability; ethical behavior; anti-corruption policy; stakeholder dialogue; environment protection; social impact; etc.
The goal of the indices is to satisfy the investors’ growing interest towards the companies that are managed in line with sustainability principles. Thus, such indices are an important tool for the investors to assess the companies and to make responsible/sustainable investments.
Following are internationally recognized sustainability indices: Dow Jones Sustainability Index /DJSI; FTSE4Good; MSCI KLD 400 Social Index; The Ethibel Sustainability Indices (ESI), etc. See: Social and Sustainability Indices
Worldwide, there are many organizations and Sustainable Investment Forums (SIFs) promoting responsible investment. Their goal is to support the practice of sustainable and responsible investments on the financial markets. Some of the largest ones are listed below:
These seven largest forums for responsible and sustainable investment also have established Global Sustainable Investment Alliance (GSIA), which promotes sustainable and responsible investment globally.
An important initiative in responsible investment field is The UN’s Environment Program Finance Initiative (UNEP FI). Established by partnership of UN’s Environmental Program and Global financial sector, its goal is to support the promotion of sustainable and responsible approaches, environmental standards, and best practices in the financial sector.
