Some of these terms used include ethical investment, socially-responsible investment (SRI), green investment, responsible investment (RI) or sustainability investing to name a few. The meaning of these many terms overlap in one way or another and many have particular meaning for different industry participants.
What are the three key common items when referring to sustainable investing?
In all these terms used, ethical investment, socially-responsible investment (SRI), green investment, responsible investment (RI) or sustainability investing, there are three key common items when referring to incorporating ESG (Environment Social Governance) information by fund management companies in the way they manage clients’ money:
- They have a long-term investment perspective – over 10 years
- Such ESG information is considered as a potential driver of additional returns and/or risk reduction – by for example anticipating potential environmental disasters such us the BP oil spillage in the Gulf of Mexico in 2010
- The impact of the investments made are measured and taken into consideration – by for example measuring the amount of jobs and hence the wealth created by a Company operating in developing countries
Throughout this and subsequent articles on this topic, the term Sustainable or Responsible Investing will be used to refer to the incorporation of ESG information in any form by fund management companies in the way the manage money.
What are the main approaches used in sustainable investing?
Over the past twenty years several distinct approaches for incorporating ESG (Environment Social Governance) information in the way fund management companies manage money have been developed. The large majority of these approaches have been focusing on the large publicly listed companies for the main reason that ESG information is most widely available via their annual and corporate social responsibility reports. Below, a short description of the most common sustainable investing (SI) approaches that are used by fund management companies today are provided:
- Positive screening: in this approach, the fund manager seeks to invest in companies that have a positive ESG performance and/or have substantial exposure to environmental/societal solutions (e.g., Tesla and its exposure to electrified transportation or pharma company Novo Nordisk and its product portfolio for obesity reduction).
- Negative screening: here, fund managers avoid investment in certain companies, industries and even countries as a result of their controversial activities/exposure (e.g., Lockheed Martin given its exposure to weapon manufacturing or the exclusion of electrical utilities as a sector as it is a primary emitter of CO2 emissions)
- Integration: in this case, ESG information on each of the companies that are part of the portfolio is taken into consideration and decision-making, as it is believed to have a positive influence on investment risks and/or returns.
- Active ownership: this approach recognizes the responsibilities of the fund management company as a shareholder of the companies in its portfolio and hence exercises its voting rights at the Annual General Meeting of Shareholders of publicly listed companies. Additionally, the fund management company enters into an active dialogue (so called “engagement”) with the Company’s management and supervisory Board to improve management practices on certain issues; for example, a control mechanism to avoid excessive remuneration to top executives or the link of their variable compensation to environmental improvements in the Company’s operations rather than only linking it to the Company’s financial improvements.
Is there a wrong or right approach to sustainable investing?
Different investment approaches are not used alone but in combination as they are not necessarily mutually exclusive, meaning that integration approaches can be combined with the exclusion of certain companies for a more comprehensive sustainable investing (SI) approach by a particular fund manager.
As mentioned above, most of the development has been carried out in the area of large publicly listed companies, but in recent times also the corporate bond and to a lesser extent the government bond asset class has incorporated some elements of the various SI approaches listed in our article last week.
A Question on Performance:
What does Academic research say about performance of sustainable investing?
Based on academic research published2,3 4 it is highly dependent on the sustainable investing “SI” approach used by the fund management company; for example, if the fund uses only negative screening whereby they exclude controversial sectors such as alcohol, tobacco, gambling and pornography from the portfolio, the fund tents to show a negative alpha (measurement of outperformance vs. market returns) compared to traditional benchmarks, meaning that there is indeed a performance sacrifice. Contrary, when positive screening approaches are applied, funds tent to show a positive tilt towards alpha creation.
What does Prosperio offer?
Prosperio – your personal investment guide, offers you the possibility to incorporate sustainability issues in your investment portfolio. In this regard, you can opt to select whether you wish to completely eliminate controversial weapons from your portfolio (e.g., cluster munitions and anti-personnel mines) and/or focus your portfolio on environmental issues such as climate change and environmental protection, on social issues such as labour rights, consumer protection or on governance issues such as management compensation or shareholder rights.
We look forward to guiding your investments sustainably!
1 Fulton, Kahn, Sharples, Serafeim (2012), Sustainable Investing – Establishing Long-Term value and Performance
2 Statman, Glushkov (2008), The Wages of Social Responsibility
3 Derwall, Koedijk, Ter Horst (2010) A Tale of Value-Driven and Profit-Seeking Social Investors
4 Hong, Kacperczyk (2009) The Price of sin: The effects of social norms on markets