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Sustainable Investments 101: Benchmark Clarifies The Alphabet Soup Of Terms In The Sustainable Investing Industry




Sustainable Investments 101: BENCHMARK clarifies the alphabet soup of terms in the sustainable investing industry


By Marlynne Bidos

Sustainable investing is an abstract term for many investors. What usually comes to mind, when one thinks of it, is additional time, reduced return, less options and a plethora of acronyms. But it doesn’t have to be so confusing or time consuming. BENCHMARK sat down with the experts to find out what you need to know.

What is sustainable investing?

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Alexandra Tracy, Chairman, ASrIA

“It’s not about hugging trees and loving children. It’s about risk management and preserving the investment over the long term,” said Alexandra Tracy, Chairman of the Association for Sustainable and Responsible Investment in Asia (ASrIA).

In general, sustainable investing means environmental and social factors are considered when making investment decisions. SRI, socially responsible investing, is used interchangeably with sustainable investing. David Doré, Research Manager at ASrIA, said, “It’s a strange thing to say. It implies that another thing is not responsible. Sustainable is more neutral.” Other acronyms include “socially conscious”, “green” or “ethical” investments.

Statistics show sustainable investing is rapidly increasing. In Europe, there were more than 48,000 sustainability themed investments in 2011. Approximately 20 per cent of all assets under management in Canada are now invested in SRI funds. In the United States, about US$1 of every US$9 under professional management can be classified as a SRI investment. The Principles for Responsible Investment (PRI) backed by the United Nations are a public commitment investors make to align their investment activities with the broader interests of society. Signatories to the principles commit to the following:

  • Incorporating ESG issues into investment analysis and decisionmaking processes.
  • Being active owners and incorporating ESG issues into ownership policies and practices.
  • Seeking appropriate disclosure on ESG issues by the entities invested in.
  • Promoting acceptance and implementation of the Principles within the investment industry.
  • Working together to enhance effectiveness in implementing the Principles.
  • Reporting activities and progress towards implementing the Principles.

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James Gifford, Executive Director, UN-backed Principles for Responsible Investment (PRI) Initiative

Currently, there are 1,192 signatories who include asset owners, investment managers, and professional service partners. James Gifford, Executive Director of the UN-backed Principles for Responsible Investment Initiative said, “The PRI principles themselves intentionally do not prescribe which issues are more or less important at any one time because it changes over time. The PRI is a higher level framework that puts the obligation on investors to seriously work out which of these issues are relevant to particular companies, sectors and regions.”

ESG

Environmental, social and corporate governance (ESG) are factors taken into consideration when measuring the sustainability and ethical impact of an investment in a company or business. Thomas Kuh, Executive Director of ESG Indices at MSCI broke down the factors MSCI considers in each category. “For environment, we look at factors that are related to climate change, natural resource use, toxic emission and waste. In the social category, we look at issues that have to do with supply chain management, labor standards and relations, employee safety, and exposure to hazardous chemicals. On the governance side, we look at many of the traditional corporate governance metrics from a best practices perspective, and also at business ethics, fraud and whether companies are engaged in anti-competitive practices.”

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Thomas Kuh , Executive Director ESG Indices, MSCI, Inc

Gifford remarked that fifteen years ago companies didn’t consider these issues relevant , but now they are at the heart of conversations. He said they are being incorporated into executive remuneration to compensate executives in a way that will encourage consideration of the long-term risks of these issues, in addition to delivering next quarter’s earnings.

Affirming this, Kuh said that demand for the MSCI indices that track ESG or SRI indicators is increasing. “I can tell you that our clients always want more coverage of more issues in more depth. There is constant demand for and interest in more coverage,” he said. The MSCI KLD 400 Social Index has tracked companies with high ESG factors since 1990, serving as a benchmark for investors whose objectives include avoiding companies that are incompatible with specific values-based criteria. Since then, it has launched a number of indices in world, developed and emerging markets that track ESG and social responsibility. In May, it launched the Emerging Markets ESG index which completed its coverage of the market.

Kuh remarked that, in his experience, he has seen evidence that higher rated companies perform better than lower rated companies, but he cautioned that the evidence varied based on the periods, economic cycles, industries and sectors. “I don’t think there is a universal conclusion. But at the same time, there is evidence in the academic literature that in the long run that you can get performance at least as good as the market with higher quality from an ESG perspective.”

CSR

The definition of corporate social responsibility (CSR) varies based on the organization. In general, it refers to how companies manage their economic, social, and environmental impacts, while balancing relationships with stakeholders. Although some have dismissed it as good public relations, if implemented, it can serve as a guide for corporate values-based self-regulation. Kuh said, “I think there is an interest in CSR becoming part of a company’s everyday strategy and practice around the world.”

A report released in April by the European Commission surveying 32,000 European Union citizens regarding their views of how companies influence society found that they consider corruption (41%), reducing staff (39%) and environmental pollution (39%) as the main negative effects of companies on society and 49 per cent said that citizens themselves should take the lead role in influencing the actions of companies through their decisions about what they buy.

The consensus is similar in Asia. CSR Asia, a social enterprise that provides services on sustainable business practices in Asia, issued a report entitled “CSR in 10”, which cites CSR experts as saying that climate change is the number one topic of concern for companies in the corporate social responsibility sphere over the next ten years. It said,
“We seem to be witnessing the beginning of ‘consumer power’ in Asia and a new role for consumer organizations. The social media is increasingly the source of emerging issues and the private sector will have to find new ways to engage with online stakeholders.” The report suggested that companies develop requisite policies that allow for disclosure and the engagement of all stakeholders.

Impact Investing

Impact investing is the use of capital in pursuit of social and environmental impact and financial returns. Impact investors usually invest in social entrepreneurship ventures which range from farming cooperatives to offering employment options for marginalized populations to building artisan industries.

Avantage Ventures’ report Beyond the Margin: Redirecting Asia’s Capital estimates that between now and 2020, the total amount of investment needs for social enterprises in the sectors of affordable housing, water and sanitation, rural energy, rural and elderly healthcare, primary education and agribusiness will be between US$44 billion and US$74 billion. If invested, it claims that money could unlock a market demand of between US$52 billion and US$158 billion.

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Philo Alto, Founder of Asia Value Advisors and Co-Founder of Asia Community Ventures

Philo Alto, Founder of Asia Value Advisors and Co-Founder of Asia Community Ventures, expects to see impact investments eventually emerge as asset classes in their own right. In his report, “Impact Investing: Will Hype Stall Its Emergence as an Asset Class?” he argued that currently the vast majority of social businesses in their seed and early stages need grant-like or venture philanthropic funding. Impact investing as an approach, according to him, are more appropriate for a small handful of fast growing social businesses with demonstrated impact and sustainable business models. “An understanding of this distinction will provide social businesses with a clearer path to funding goals that are in line with their intended social missions, rather than forcing them to alter their business models to cater to impact investors,” he said.

So how does impact investing differ from sustainable investing? Impact investing drives social change from an entrepreneurial context, whereas sustainable investing focuses on the long-term risks and opportunities arising out of environmental, social and corporate governance issues without directly seeking a positive impact.

Active Ownership

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Penny Shepherd, Advisor, UK Sustainable Investment and Finance Association, UKSIF

“There is an overlap between sustainable investment and active ownership, but one is not a subset of the other,” said Penny Shepherd, Adviser at the UK Sustainable Investment and Finance Association (UKSIF). “By active ownership we mean long term ownership to protect and increase the value of assets. We are talking about genuinely increasing and protecting the value of the company.” The global financial crisis is a prime example of why active ownership is important and increasingly being discussed. The sentiment exists that shareholders could have exerted their rights to monitor and challenge management, when they were not acting in the interests of investors. A modern day example of this is the PRI Clearinghouse, a global platform for collaborative engagement initiatives. Gifford said the Clearinghouse ran a three year anti-corruption engagement where a coalition of twenty investors, representing US$1.7 trillion of assets under management, engaged with twenty-one companies that had significant exposure to corruption-related risk to encourage them to improve disclosure of their anti-corruption strategies, policies and management. “The result was that 75 per cent of the companies targeted significantly improved their transparency on these issues.”

To become a more active owner, Shepherd advises that owners understand the skills of engagement as part of the process of assessing and selecting fund managers and require their asset managers to engage with companies as part of their investment contract. Although interacting with companies does not always have to be done through a third party, Shepherd explained an advantage is that a person that has specific skills in engagement potentially may have more influence with the company, than if you were a shareholder working alone. BM

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