Sustainable investing is very topical in the investment management industry at present. However there is confusion as to what investing ‘sustainably’, actually means.
Sustainable investing is a broad term covering a range of investment approaches that incorporate environmental, social and governance (ESG) factors into the investment process. Two categories within this framework, Responsible Investing and Ethical Investing, are discussed below.
The definition of responsible investment, according to the UN Principles of Responsible Investing (UNPRI), is “an approach to investing that aims to incorporate environmental, social and governance factors into investment decisions, to better manage risk and generate sustainable, long term returns”. Generating financial returns remains the key objective under this approach to investing. However, advocates of responsible investing place greater emphasis on and consideration of ESG issues in their investment processes as there is an inherent belief that assessment of these factors will ultimately drive financial returns and investment performance.
Examples of how ESG factors may be integrated into a responsible investing framework are detailed below:
Environmental – a company that has high carbon emissions may be at risk of a tighter regulatory framework, or risk having stranded assets if alternative technology displaces highly pollutive industries. The key question is whether it is a sustainable business. Conclusions to these questions are factored into cash flow forecasts and reflected in the valuation placed on this business and will impact the investment decision.
Social – key considerations for this factor are how well the company treats its workers, how highly it values health and safety, and how it interacts with local communities. These factors can provide insights into the culture of a business and be important lead indicators for financial performance.
Governance – this factor looks at issues such as the composition and experience of the board of directors, the company’s approach to executive remuneration, and accounting and tax policies. Investment processes often limit the analysis to the quality and depth of executive management. Under a responsible investing framework, there is a more holistic consideration of corporate governance issues that allow investors to judge how sustainable business performance is.
This on the other hand, is a style of responsible investing that takes more of a ‘screening’ approach to its investment universe to exclude industries that are not believed to be socially ‘ethical’ (for example, firms that produce tobacco products, firearms, and munitions), or actively include businesses that are perceived to contribute positively to society. Under this style of investing the social, moral or ethical objective takes precedence over the financial investment objective.
Ethical investing tends to target specific themes, most commonly environmental or social issues, and then limits the investment universe to exclude these companies, regardless of the investment opportunity.
In summary, the term ‘sustainable investing’ covers a broad range of investment styles that attempt to incorporate ESG issues into the investment process in some form. As we have seen, Responsible Investing and Ethical Investing are two very different approaches – Responsible Investing is influenced by ESG factors in the pursuit of a superior and more sustainable risk/return outcomes; whereas Ethical Investing is directed by ESG factors that may impose negative or positive screens restricting or directing investment in certain industries or companies.
At Milford, we are dedicated to growing the wealth of our clients and the overall prosperity of the New Zealand economy through responsible investing. We focus particularly on corporate governance of the entities we invest in as well as environmental and social factors. As part of our commitment to responsible investing, Milford is a signatory to the Principles for Responsible Investment and a member of the Responsible Investment Association Australasia.
Disclaimer: This blog has been prepared by Milford Australia Pty Ltd ABN 65 169 262 971 (AFSL 461253). You should not rely on any information in the blog in making any investment decision.
It is for general information only and does not take into account your objectives, financial situation or needs. You should consider, with a financial adviser, whether the information is suitable for your circumstances. Past performance is not a guarantee of future performance.