Key Approaches to ESG Investing
Sustainable and responsible investing (SRI) is a powerful force shaping the way many corporations, agencies and stakeholders worldwide are run. At PULSE ONLINE, we reported last November on the several drivers behind this transformational trend. By putting environmental, social and governance (ESG) policies at the top of priorities, investors are leaving a mark in complex global issues, and changing the investment community itself along the way.
According to the most recent data from the Global Sustainable Investment Alliance1 (GSIA), 30% of professionally managed assets globally, or USD 21.4 trillion, employed ESG strategies at the start of 2014. That implied growth of 61% in two years. The GSIA’s bi-annual review is considered the leading global research on the size of the responsible investment industry. PULSE ONLINE will cover the 2016 review when it is available later this year.
There are several ways in which institutional investors can adopt SRI in their investment processes. GSIA, for instance, categorizes the following broad approaches:
- Exclusion: Removal from an investment universe of holdings involved in blacklisted activities.
- Best-in-class selection: Positive screening of top-ranked companies within a sector using ESG criteria.
- ESG integration: Inclusion of ESG factors into traditional financial analysis before investment decisions; it may be an explicit or a systematic process.
- Sustainability-themed: Dedicated investments targeting specific themes such as water or energy efficiency.
- Norms-based screening: Assessment of companies relative to internationally set standards of sustainability.
- Shareholder stewardship: Engagement of investors through voting and board activism in policies aligned with ESG.
- Impact investing: A more recent denomination where investors channel funding to social organizations or enterprises to tackle social challenges.
In Europe, as is the case worldwide, exclusion and ESG integration are the more popular approaches, data from Eurosif, the European association for the promotion of SRI, show. The former dates back decades ago to flagship campaigns such as the ban on military armaments investing.
ESG as a valuation tool
ESG integration into analytical screening and models has grown in size and momentum, spurred by investment sponsors who demand principles as well as returns. Central to the growth in ESG integration is a burgeoning academic debate about how and if ESG can be measured in financial terms, a debate that is likely to enrich ESG integration strategies.
Sustainability reporting that follows common standards will also take time to be consolidated and codified, if the history of financial reporting standards can serve as a guide. PULSE ONLINE reported on some of the challenges of setting up an appropriate ESG measurement framework in an article published last December.
A fuller fiduciary duty
In April 2006, the Principles for Responsible Investment, a United Nations-convened initiative, was launched. The Principles –developed by a group of institutional investors– encourage the use of responsible investment to enhance returns and better manage risks, and pushed SRI into a new phase. More than 1,400 signatories from over 50 countries representing USD 59 trillion of assets now back the Principles.
STOXX introduced its first STOXX® Global ESG Leaders Index family in 2011, based on data provided by Sustainalytics. The indices follow key ESG performance indicators designed by the European Federation of Financial Analysts Societies, and provide a transparent and rules-based way for investors to track the performance of corporate leaders in sustainability. Since then, STOXX continues to expand its broad offering in sustainable and responsible investing through many ESG-themed indices with the most recent being the STOXX® Low-Carbon index family and STOXX® Global Climate Change Leaders.
A long way ahead
Through SRI, money managers, investment advisors and asset owners, who increasingly understand that sustainability risks are financially material, are changing public policy and global standards. A next step will be the standardization and codification of international sustainability reporting formats. No doubt this exciting trend will continue to alter the investment landscape in years to come.
1Global Sustainable Investment Review, 2014, GSIA.
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