What is Ethical Investing?
Responsible investment is an umbrella term to describe an investment process that takes environmental, social, governance (ESG) or ethical investment considerations into account.
This process is in addition to the fundamental investment selection and management process.
It involves the inclusion of one or more of the following practices in the research, analysis, selection and monitoring of an investment.
Responsible Investment Screening
In the conventional investment process, screening is used to develop a shortlist of investment options based on preferred financial criteria. These criteria could include leverage metrics or valuation ratios. In the case of responsible investment, however, screening also includes environmental, social, governance (ESG) and ethical factors, as well as financial criteria.
Responsible investment screening is used in many ways. It can be applied to select investments based upon relative performance on specific issues (such as carbon emission benchmarks or governance standards). Screening can also exclude entire sectors or activities (such as gambling or those who abuse human rights). It can be used for equities as well as property, fixed income and infrastructure. Additionally, this can be employed either before or after the financial analysis has taken place. Responsible investment screening usually supported by a pre-determined methodology that is clearly defined and transparent.
The competitive performance of screened investments depends on both the screening methodology and the final portfolio construction. This seeks to minimise correlation and volatility and maximise diversification and risk-adjusted return potential. Negative screening is the term used to describe the exclusion or avoidance of an investment. This exclusion is based upon environmental, social, governance or ethical factors. Contrastingly, positive screening is the favourable consideration of an investment opportunity based upon these issues.
Best of Sector
This investment style implies that all industries should adopt higher standards of ESG practice in order to meet the expectations of society and to achieve sustainable and profitable business goals. This process does not involve negative screening, but rather identifies those companies with superior ESG performance from across all sectors.
Portfolios which contain only those investments that adhere positively to a particular sustainability theme such as environmental technology, carbon intensity, sustainable agriculture and forestry, water technology, waste management, community investing, affordable housing, sustainable property and infrastructure, human rights, microfinance or governance. This category also includes multi-strategy portfolios which may contain a variety of asset classes or a combination of these themes.
This emerging investment style involves actively placing capital in businesses and funds that are directed toward solving specific and significant environmental and social challenges. Additionally, they provide returns to the investor that range from principal to above market. By leveraging the private sector, these investments can provide solutions at a scale that purely philanthropic interventions usually cannot reach. Investors usually include high net wealth individuals, institutional investors, charities, corporations and foundations. These stakeholders invest across a wide range of asset classes and where success is measured by a combination of financial returns and environmental and social impact.
ESG integration is the incorporation of environmental, social and governance factors into the investment decision-making process. More specifically, ESG knowledge is used to inform the analysis of risk, innovation, operating performance, competitive and strategic positioning, quality of management, corporate culture and governance and to enhance financial valuation, portfolio construction, engagement and voting practices.
Engagement With Companies on ESG Issues
Engagement is the process by which an asset manager, asset owner or specialist firm will contact companies to build the business case for better management of ESG issues. This can sometimes involve the formal or informal collaboration with likeminded investors on common issues. This increases the likelihood of a positive outcome from the engagement process.
Shareholder Activism – Voting and Resolutions
Investors who are active owners will exercise their right to vote according to their values and their right to raise resolutions in order to achieve better management outcomes. Investor activism on governance issues has grown substantially in the last ten years, particularly in Britain and the United States. This is especially in relation to director elections and remuneration. More recently, environmental and social resolutions have also grown in number and support in the United States. Additionally, in 2011 Australia’s first dedicated climate change shareholder resolution was brought forward.