What is responsible investment?
Responsible Investment (RI) involves integrating “environmental, social and corporate governance” (ESG) considerations into investment decisions due to the belief these factors can have an impact on financial performance. In short, it involves incorporating financial and non-financial factors into the investment decision making process.
RI can be broken down into a few basic strategies:
Basic ESG compliance, where investors determine certain investments or practices that will be excluded from their portfolio.
Active ESG compliance where investors positively screen, seeking to direct more funds towards investments which contribute towards some positive social good.
Impact investment, where the core purpose of the investment is to deliver a blend of positive social impact and financial return.
Why is RI becoming more popular?
Firstly, the consequences of ignoring ESG factors can be catastrophic for investors. For example, investors who did not consider governance concerns at Volkswagen saw the value of their investments plummet when the company faced billions in fines from the emission scandal.
Secondly, there is growing evidence that ESG star performers often outperform the market. As recently reported in the Financial Times, companies that outperform on ESG factors also outperform the market financially. Thus, the combination of “being good and doing good” is understandably attractive to a wide range of investors.
Finally, it has become easy and affordable to identify RI opportunities and to invest in them. From BlackRock, to ESG-focused firms like Impax Asset Management, investors have a diverse range of opportunities in which to allocate funds. According to the Forum for Sustainable and Responsible Investment, one in five of every dollar under professional management in the US – c.$9 trillion – is invested according to socially responsible principles.
Is RI a bubble?
There are alternative perspectives on the RI boom which raise valid concerns around its popularity. For example, while stocks can drop rapidly after reports of ESG-related scandal, many can quickly rebound. Recent examples include Wells Fargo, Barclays and United Airlines, all of which recovered their original share price value soon after large public scandals.
Additionally, most of the data that reflects positive performance from RI portfolios has been collected in the “post-financial crisis” landscape. While investors may assume the information is reliable, forecasting market trends post-2008 has been a challenge. Finally, there are few standardised accounting practices for RI, making assessments about performance and market share inconsistent.
What needs to change about RI in the long-term?
As RI gains popularity, it must undergo greater scrutiny to ensure its long-term viability. Investors should adapt a robust approach to assess RI portfolio performance and ensure more rigorous, standardised criteria are established when screening for responsible stocks. In addition, organisations managing RI investment portfolios must properly document their RI strategies.
What can we conclude about RI?
It’s clear that RI is here to stay. But RI approaches need to become more transparent to fairly assess their impact and their risk/return profile. Once these things are clear, investors will be able to credibly say that investing in any other way is simply irresponsible.
Peter Babudu is an Executive Director at Prime Advocates. If you would like to discuss any issues raised above further please contact email@example.com