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Responsible investment: straining the alphabet soup



One in five professionally managed dollars in the US is now invested with environmental, social and governance (ESG) factors in mind, according to the latest data from the US SIF Foundation. Its European counterpart Eurosif finds that more than half of assets in Europe can be categorised as “sustainable and responsible investments” (SRI). Investors managing more than $60 trillion, perhaps half of the global pool of managed assets, have signed up to the UN-backed Principles for Responsible Investment (PRI).

Three impressive statistics – and three different acronyms, covering a wide range of investment approaches, and causing considerable confusion in the marketplace.

So how should investors make sense of the responsible investment alphabet soup?

Part of the problem is that many of the acronyms and expressions used lack an agreed definition, and are often used casually or interchangeably. But sloshing within the soup are terms and approaches that have more precise meanings, and which can be used to understand exactly how a self-described responsible or ESG investor approaches the business of investing.

As a starting point, SRI, responsible investment, and ESG investing can be considered umbrella terms that cover a multitude of approaches. Put simply, they involve some consideration of environmental, social, ethical and/or governance issues in the selection and management of investments and typically, they imply a relatively long-term investment horizon.

As is clear from the above, ethical investment is a sub-set of responsible investment. The approach – avoiding companies whose activities conflict with an investor’s values – was borne out of campaigns against apartheid in South Africa in the 1980s, and several religious groups also adopted a similar approach and pioneered the modern SRI industry. For that reason, and because many retail SRI products still take an ethical investment approach, many people continue to conflate responsible investment or SRI with ethical investment.

However, ethical investing is very much a sub-set of today’s responsible investment world. Ethics are subjective, and the investment approach – excluding companies and often entire industry sectors, such as tobacco, gambling and defence, adds to a portfolio’s volatility and risks underperformance compared with the market as a whole. Ethical investors are commonly understood to be prepared to accept this risk of underperformance as a price worth paying to invest in line with their values.

ESG integration

For most responsible investors, however, the starting point is that an understanding of ESG issues can help improve investment returns, by identifying risks and capturing opportunities that might be overlooked by the wider market.

Such an approach can be characterised as ESG integration (as opposed to the somewhat vaguer ‘ESG investing’). It involves investors integrating a rigorous assessment of ESG factors with their existing financial analysis, with a view to generating investment outperformance.

This integration is the first of the six principles to which PRI signatories commit. There is, of course, a range of options as to how that ESG analysis is used to inform investment decisions.

One approach is best-in-class investing, where ESG scores are used to identify the top ESG performers in each industry sector. This has the advantage of allowing managers to construct portfolios that mirror the mix of industry sectors found in the wider market, preventing too much divergence in returns from market benchmarks. The downside, however, is that best-in-class investing tends to focus on how a company is run, ignoring what it produces. For example a well-run producer of gas guzzling SUV vehicles might score more highly than a manufacturer of hybrid or electric vehicles.

Another danger with ESG integration is that it can pay insufficient attention to the ‘materiality’ of various ESG factors. Consumer protection issues are much more important than climate change for the performance of a retail bank, for example, while strong anti-bribery policies are a higher priority for a pharmaceutical firm than energy efficiency. Failure to control for materiality can lead to perverse outcomes.

Meanwhile, larger companies tend to have more developed ESG policies and processes, allowing them to score more highly than their actual performance might suggest. This has led some to question the usefulness of ESG fund ratings for companies (and investment funds, for that matter) offered by a growing number of service providers.

Incorporating ESG risks and opportunities

At Impax we use ESG analysis as one step of our rigorous investment process to identify the providers of solutions to the pressing environmental problems we face as a result of population growth, changing demographics and increasing consumption. This approach could be categorised as thematic ESG investing, and it can be particularly successful when applied to under-researched mid- and small-cap companies.

Impact investing

There is also another responsible investment strategy – impact investing that is gaining traction as an allocation style, particularly within the wealth market, as families and younger inheritors of wealth seek to align their investments with their values.  We have three strategies across listed equities, as well as renewable power generation and sustainable property in real assets which tend to appeal to this growing audience. Our investment process directs capital towards companies and/or real assets with quantifiable environmental benefits, in addition to financial returns.

Listed equity products have been slow to adopt a sophisticated approach to positive impact measurement and typically look only at ESG risk mitigation, whether through negative screening or incorporating aspects of ESG strategies. Impax is one of the first take the language and quantitative evidence of positive impact investing to a listed equity strategy. The first step in our investment process is to establish that a company generates at least 20 per cent of its revenues from environmental market exposure (on average across the portfolio this is currently around 60 to 80 per cent).  It is this pure play approach that delivers a truly differentiated portfolio and enables measurement of the positive environmental impact. Such an assessment allows us to demonstrate to our investors the real-world positive environmental outcomes of our investment decisions, and track progress over time.

[We also see a growing number of investors are considering measuring impact, encouraged by the launch in 2015 of the UN Sustainable Development Goals (SDGs), 17 objectives to tackle global social, environmental and development challenges. However, because the SDGs are broad in scope – one metric is for job creation, for example – there is a risk that some investors will seek to claim that business-as-usual investing has helped deliver against the SDGs. We think that such claims should be met with scepticism: intention is as important as outcome for investors claiming to be impact investors.]

In conclusion

So much for defining our terms. What does all this mean for investment performance? For ethical investing, the calculation is clear: restricting the size of the investible universe increases the volatility of returns compared with the broader market. For ESG integration, however, our experience and the emerging academic consensus is that investing responsibly need not sacrifice returns and, in the majority of cases, and particularly over the longer term, integrating ESG factors provides investors with additional information and insight, helping them to outperform.


Written By Lisa Beauvilian, Head of Sustainability & ESG, Director 

Lisa joined Impax in 2010 and is responsible for environmental policy and legislation investment research and non-financial or Environment, Social and Governance (ESG) analysis.

She started working in the financial industry in 1999 and previously worked as Executive Director in the Investment Management Division of Goldman Sachs International. Lisa has also worked as an independent consultant focusing on environmental policy research and analysis. She is a Trustee at the International Institute of Environment and Development (“IIED”). Lisa has an MSc in Environment and Development from the London School of Economics and an MSc in Finance from the Hanken School of Economics in Finland.


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