Responsible investing is on the rise, but what does that mean for investors?
Responsible investing is largely thought to be the incorporation of environmental, social and governance (ESG) factors into the decision-making behind the investment process. ESG factors span across a wide range of issues which traditionally do not constitute part of financial analysis yet may have financial relevance.
Examples of these might include: how businesses deal with climate change especially through waste disposal and water usage; how good their health and safety policies are at mitigating accidents; how they respond to human rights issues in the company and throughout the supply chain; how workers are treated; the structure and compensation of the board and how accountable they are for company performance. The list goes on, and is one which will forever be growing and developing.
How big is the responsible investing sector?
ESG investing is continually growing in significance and magnitude amongst both retail and institutional investors.
Earlier this year the Global Sustainable Investment Alliance released their 2018 review, indicating sustainable investing assets in the five major markets stood at $30.7trn at the start of 2018, growing by 34% in two years.
Europe continues to manage the highest proportion of sustainable and responsible assets, accounting for nearly half globally.
Impressive growth from Japan and consistent growth in the US has seen their share of the pie increase.
Figure 1 illustrates the growth of sustainable and responsible investing in the US alone. In terms of strategy, ESG integration comes second only to negative/exclusionary screening on a global basis and is estimated to cover $17.5trn of assets, growing by over two- thirds in the past two years.*
The world’s leading proponent for responsible investment, the PRI (Principles for Responsible Investment) is a UN-backed, global initiative with the aim of advancing the integration of ESG into analysis to enhance returns and better manage risks.
Today, it has over 2,300 signatories and spans across a total of $86.3trn worth of assets (see Figure 2).† Despite the rapid growth of ESG investing into the mainstream, the rise of it has not been smooth with many questioning its link to improved returns.
What does it mean for investors?
Much debate has been centred on whether or not ESG investing aids performance.
A number of studies suggest companies fully embracing ESG practices tend to exhibit a lower cost of capital, lower volatility and fewer instances of fraud, bribery and corruption. In contrast, others suggest the evidence of ESG adding value is less than concrete due to the complex and ill-defined nature of the potential factors.
It has also been argued ESG factors could increase an investment portfolio’s risk due the reduced diversification potential that arises with a smaller investment universe. In reality, these arguments are becoming less and less relevant due to greater awareness and the adoption of ESG beliefs becoming increasingly focussed on allocating capital for positive impact.
In 2015, a vast meta-study which aggregated more than 2,000 empirical studies relating to ESG and financial performance found a positive relationship between ESG and corporate financial performance.
The research concluded the orientation toward long-term responsible investing should be important for all kinds of rational investors in order to fulfil their fiduciary duties and may better align investors’ interests with the broader objectives of society.‡
Sources: *US SIF: The Forum for Sustainable and Responsible Investment, 2018); †Principles for Responsible Investment , 2019; ‡Friede, Busch, & Bassen, 2015.
Three funds to capitalise on the responsible investing opportunity
BMO can be deemed as one of the leading players within the field of Socially Responsible Investing (SRI) due to their large Governance and Sustainable Investment team and the Independent Committee of Reference.
The investment process favours companies promoting sustainable development and making a positive contribution to society.
Negative screening is also applied to avoid certain unsavoury companies and sectors. The fund aims to provide capital growth by investing in an actively managed portfolio of ethically screened diversified global equities.
The fund’s SRI investment approach forms the core of the overall strategy. The team takes steps to identify attractively valued, responsible and sustainable businesses that will benefit or provide solutions to one or more key themes in: better resource efficiency, improved health and greater safety & resilience.
Use of the Sustainability Matrix helps to analyse a company’s core business, product sustainability and management quality.
This is all overseen by the Advisory Committee to ensure consistency is upheld and guidance on the suitability of holdings is given.
The fund represents a viable option for investors seeking a mixed asset solution with a relatively strong preference towards equities.
This investment grade fund targets high yield with a strong ethical overlay.
Once investment themes have been developed, the team carry out credit analysis to find the assets which work best within the thematic framework.
Cash flow and strong balance sheets are key in determining bond selection. The ‘Plus’ is conviction – that to achieve above average long-term performance, the team feel they must think differently to the market.
After that, an ethical overlay is applied which consists of a negative screening followed by a positive screening.
Input from Rathbones Greenbank makes good use of this specialist ethical resource within the group.
This fund is suitable for SRI investors particularly seeking income over capital growth.
Thomas Rosser is a research analyst at The Share Centre.