Responsible Investing – why, what and how?
Why is responsible investing a hot topic? What’s the difference between SRI and ESG? Can non-financial and financial goals co-exist? Russell Investments discuss the why, the what and the how of responsible investing.
Whether you’ve seen it referred to as SRI (socially responsible investing), ESG investing (environmental, social and governance) or just plain old ethical investing – there are subtle differences, but they all point towards a common goal: being a responsible investor.
What is the appeal of responsible investing anyway?
Many investors around the globe are interested not only in the financial outcomes of their investments – but also the impact their investments may have, and the role their assets can play in promoting certain global issues. Such investors often cite a sense of responsibility to do good, socially and environmentally.
However, with the various climate action plans and agreements, responsible investing is quickly developing into a corporate priority. Whether that’s because companies have pledged to reduce their carbon footprint or to support equality– small and large business requirements are growing.
SRI investing vs ESG investing
SRI – exclusionary screening
To many, today’s responsible investing brings back memories of SRI - Socially, Sustainable and Responsible Investing. In the past, it has typically employed an exclusionary screening based on social issues rather than investment issues. For example, electing to divest or not invest in: ‘sin stocks,’ like alcohol, tobacco, or pornography; or South African companies during the Anti-Apartheid Movement (originally known as the Boycott Movement) of the 1970s and 1980s; or fossil fuels today.
A limiting feature of SRI screens was that they typically were not investment-based. Rather, securities that did not meet some social or environmental criteria tended to be stripped out of the portfolio, without consideration for the investment implications. While the portfolios were deemed socially responsible, they often did not meet investor expectations for returns and therefore earned a sub-par reputation. For the investors who preferred this approach, this was an acceptable trade-off between the non-financial gain on SRI against the financial give-up on return. It reflects how different investment beliefs translate into divergence in investor utility functions with divergence in appreciation of investment outcomes, as a result
ESG – complementing due diligence
The implementation of ESG is more sophisticated than SRI. ESG refers to environmental, social, and governance issues that an investor may consider when making investment decisions. Examples of ESG issues include:
- Climate change, air pollution, energy efficiency (i.e. Environment issues);
- Gender and diversity, human rights, labor standards (i.e. Social issues);
- Board composition, executive compensation, whistleblower schemes (i.e. Governance issues).
While some investors may want their portfolio to reflect their own convictions about important global issues, others may see ESG as a potential way to impact investments positively. Either way, ESG considerations should not serve as a substitute for typical due diligence about the investment process of an investment. Rather, they can serve as a complement.
Can non-financial and financial goals co-exist?
We believe that non-financial and financial goals can, and do, co-exist. Our independent research has shown that active managers’ intent to add long-term value through security selection is leading many of them to ESG-type securities. While the manager may or may not be purposefully screening for ESG factors, their investment criteria often identifies securities which result in significant positive ESG tilts. This implies that active managers within their stock selection process are seeking characteristics within companies that not only serve to generate positive excess returns, but simultaneously result in an improved ESG profile of their portfolios. Some do this as part of explicit investment beliefs on ESG while others may be doing this by coincidence.
The key in portfolio construction is to start with good portfolio management and focus on outcomes. In fact, investors interested in seeking a positive tilt toward responsible companies or assets in their portfolios may find that their active products already have one.
Over the years, our investment specialists have produced numerous thought leadership pieces discussing the ins and outs of being responsible investors.
Here are our favourite responsible investing blogs from over the last 3 years:
- ESG in fixed income – do bond managers walk the walk?
- From brown to green energy: How investors can adapt their portfolios in the transition to a low-carbon
- Proxy voting and the effective functioning of markets
- Have Bond Managers formally integrated ESG into their investment processes?
- Win for Big Oil and a Win for the Environment
- New evidence of the financial impact of ESG factors
- Wonga, Welby, Values and Value