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Responsible investment: straining the alphabet soup

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Lisa Beauvilian

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.

Features

Green Weddings Trend: Why 70% of Newlyweds Are Going Green

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A couple of months ago, my best friend got married to her new husband. They are both very eco-conscious people, so they decided to have a unique twist on their wedding. They asked for the following:

  • They arranged a carpool with their friends.
  • They didn’t have any balloons. Instead they used umbrellas.
  • They used plant materials instead of plastic confetti.
  • My friend insisted her husband not purchase a diamond. In addition to being ecologically conscious, she didn’t like the idea of having a stone that was used in conflict zones.

My friends aren’t the only ones making these changes. In fact, nearly a quarter of all newlyweds are organizing green weddings.


Green Weddings Are Becoming the Norm

People are more concerned about green living than ever before. They are trying to incorporate environmental protectionist ideas into every facet of their lives, even the most intimate, such as marriage. A growing number of people are trying to have green weddings, which can make a big difference in reducing their carbon footprint.

How much of a difference can this make? Here are some statistics to bear in mind:

There are a number ofreasons that green weddings are becoming more important. Here are a few.

People Are More Worried About Environmental Preservation than Ever Before


Green living in general is becoming a greater concern for most people. Even younger conservatives are breaking from their older counterparts by insisting on fighting climate change. According to a poll from Pew Research earlier this year, 75% of Americans say that they are very concerned about protecting the environment. Having green weddings is a good way to act on this concern.

One of the biggest changes people are making is using recycled products for their green weddings. This is explained by the research from Pew:

“Overall, 32% of U.S. adults say they are bothered a lot by people throwing away things that could be recycled. Roughly six-in-ten Americans (61%) who say they always try to live in ways that protect the environment say it bothers them “a lot” when others throw away things that could be recycled. Among those who are less focused on environmental protection, only a quarter say it bothers them a lot when others don’t recycle. People who are environmentally conscious are also twice as likely as others to say that seeing someone incorrectly putting trash in recycling bins bothers them a lot (42% vs. 21%).”

Indifferent Politicians Are Driving them to Take More Initiative

Many politicians in power have been very hesitant to take action on climate change. Many of them have openly stated that it is a hoax. These politicians are forcing people to do what they can in their own lives to make a difference. Making small changes, such as hosting green weddings, is a great way to improve the environment without waiting for political momentum.

Cost and Simplicity

A couple of the biggest reasons that people want to host green weddings have nothing to do with their concern for the environment. Running green weddings is simply cheaper and simpler than having a massive, traditional one. One of the biggest changes is that they are buying green engagement rings from the best brands.

Green Weddings Are the Future

Green weddings have become very popular over the past few years. They will probably account for close to 90% of all marriages by 2025. People that are planning to get married should look into the benefits and plan accordingly.

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Features

Green Tech Start-Ups: Are they the Future?

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Endless innovations are occurring in green companies, reinventing the industries they belong to. Gradually, they are beginning to amass more success and popularity. Consequently, these factors serve as a good indicator for green technology businesses, and their development must begin somewhere.

Green tech start-ups boast a wide array of opportunities for the economy and environment, while boosting recruitment openings with valuable services. While the technology industry is littered with high revenues and competition, the green tech start-ups are the clear sign of a cleaner future.


Fulfilling a Genuine Need

Many tech companies will market themselves as the ultimate tech giants to shift stock and make profit. As they all vie for attention through warped corporate rhetoric, there is only one ethical winner; the start-up green tech company.

Some argue that mainstream tech businesses have grown far too big, branching out into other industries and standing between the consumer and practically everything they do. However, green tech start-ups go beyond the shallow ambitions of a company, answering a call to sincerely help the customer and climate in any way they can. Of course, this is an attractive business model, putting customers at ease as they contribute to a humanitarian cause that is genuine through and through.

After all, empathy is a striking trait to have in business, and green tech start-ups maintain this composure by their very nature and purpose.

Creating Opportunities

Despite the pursuits for clean energy still needing more awareness, green tech is an area that is ripe for contribution and expansion. There’s no need to copy another company or be a business of cheap knockoffs; green tech start-ups can add a new voice to the economy by being fresh, fearless and entrepreneurial.


Technology is at its most useful when it breaks new ground, an awe that eco-friendly innovations have by default in their operations. Of course, green tech start-ups have the chance to build on this foundation and create harmony instead of climate crisis. Ultimately, the tech advancements are what revolutionise clean energy as more than an activist niche, putting theory into practice.

Despite the US gradually becoming more disengaged with green technology, others such as China and Canada recognise the potential in green technology for creating jobs and growth in their respective economies. The slack of others spurs them on, which creates a constant influx of prospects for the green tech sector. Put simply, their services are always required, able to thrive from country to country.

A Fundamental Foresight

Mainstream technology can seem repetitive and dull, tinkering with what has come before rather than turning tech on its head. Since 2011, technology has been accused of stagnation, something which the internet and petty app services seem to disguise in short reaching ideas of creativity.

However, green tech start-ups aren’t just winging it, and operate with a roadmap of climate change in the years ahead to strategize accordingly. In other words, they aren’t simply looking to make a quick profit by sticking to a trend, but have the long-term future in mind. Consequently, the green tech start-up will be there from the very start, building up from the foundational level to only grow as more and more people inevitably go green.

They can additionally forecast their finances too, with the ability to access online platforms despite the differing levels of experience, keeping them in the loop. Consequently, with an eye for the future, green tech startups are the ones who will eventually usher in the new era.

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