Investing to ensure a better society and to secure the environment is everyone’s responsibility. Which is why the work of wealthy investors and philanthropists is so important, especially in Asia where the environmental issues are so great, where corporate graft is still endemic and where poverty is still a major problem.
The principles of responsible investing are also an important part of the puzzle for wealthy investors who are concerned to create and preserve their wealth and values for this and the next generation. Responsible investing aims to maximise returns on two fronts: returns that are in line with market performance and returns that provide a positive social impact. For individuals it is usually based on investing in listed securities via a mutual fund. Also, including ESG (environment, social, governance) factors, a company’s goals and those of an investment policy can be aligned, reputation risks can be avoided, risk management can be improved and returns on capital employed can be increased.
Martina Macpherson, managing partner at Sustainable Investment Partners, UK-based specialist in the field, says, MartiMar“Responsible investment strategies are vital to support the betterment of society. There are funds available for all types of investor, including pooled investment vehicles that enable individuals to invest in stock portfolios managed according to a variety of SRI (socially responsible investment) strategies.”
SRI strategies are applied to a range of different investment styles. Most SRI funds are actively-managed and are based on the premise that sustainability analysis is one factor that can enhance the performance of an active fund manager. For a ‘best-in-class’ approach, the portfolio manager screens and selects companies that are ‘leaders in sustainability’ – within their sector – and that deliver the best ESG performance. In this way, no sectors or goods and services are prematurely excluded from the investment world. Instead, they are compared with other companies which fall within a particular peer group – by using specific ESG ratings which are based on non-financial factors. The ‘best-class’ approach even goes one step further and compares individual sectors with each other. This means that companies with a sector – which is marked lower in comparison to another sector – are excluded from possible investment.
It is quite common for a number of SRI strategies to be deployed within a single fund – such that a ‘best-in-class’ fund may also apply some ethical screens, allocate a portion of its assets to clean technology stocks, and actively engage to encourage corporate improvement.
Another form of positive screening is the ‘thematic’ approach. This involves a comparison across multiple industries and is carried out to identify companies and sectors that are providing solutions to the pressing ecological and social issues of our time – such as climate change and water constraints.
There is an assumption that only by investing with an active manager can you properly engage in the SRI process, since by definition the manager needs to be making some active decisions on which companies to include and exclude from the portfolio. However there are some passive funds that track the major SRI indices. The best-known SRI funds are those which are offered to retail investors through open-ended mutual funds. There are also ETFs available to track both screened indices and thematic ones.
Putting pressure on companies
In general, rating a company for ESG involves assessing or evaluating it in a comparative way against standardised benchmarks. In the case of ESG ratings, the criteria concentrate on assessing the environmental impact of the manner in which a company conducts its business, its attention to social considerations and the robustness of its governance framework – and that of its supply chain.
There is definite evidence of the extent to which companies’ sustainability strategies are motivated by the work of active fund managers and their clients. The global ESG research and rating agency oecom research, in cooperation with the UN’s Principles for Responsible Investment and the UN Global Compact, conducted a survey of international companies in 2013. Overall the results were positive, as the following selected findings from the study show:
A tangible difference
Sustainable investors are convinced that incorporating ESG criteria can help them to understand the complex web of chance and risk wrapped around investments in a more comprehensive way. Numerous empirical studies support this assessment: A Harvard Business School study conducted in 2011 showed that the returns for those investing in US companies that actively followed social and eco-political guidelines, were superior to so-called “low sustainability” companies.
Over 100 relevant studies on sustainable investment were examined by Deutsche Bank in 2012. The findings were that 89% of the studies showed that companies whose sustainability management was rated positively also performed better in economic terms. They have lower capital costs and represent a lower risk for investors. The authors concluded that all investors who set store by shareholder value should integrate analysis of companies’ sustainability performance into their investment strategies.
A study published in 2011 by the asset manager RCM, showed that the inclusion of ESG criteria enables outperformance in the long run. For the period between 2006 and 2010, RCM analysed the effect of including ESG criteria on the performance of portfolios based on various MSCI indices. It showed that investors could have increased their profits by 1.6 per cent per year over a period of five years if they had invested in companies with an above-average ESG performance.
Sustainable and responsible investing, therefore, has the potential to attract a large part of a wealthy investor or family office’s traditional investment capital if it meets the financial and the values dimensions of investing. A study by ASrIA, the Association for Sustainable & Responsible Investment in Asia, puts the total volume of sustainable capital investments in Asia at US$74 billion at the end of 2011. As in Europe, the entire spectrum of SRI strategies is being used. The ‘integration’ approach, taking social and environmental criteria into account in traditional financial analysis, is particularly common.
Martina Macpherson concludes, “In spite of the many challenges facing all investment markets over recent years, the market for socially responsible investment has continued to grow and even demonstrated significant outperformance against ‘mainstream peers’ in some years. As a result there are many different ethical, social and environmental issues that can now be integrated into investment decisions. Some strategies relate to increasingly important business and societal issues – others are more about reflecting investors’ personal (or organisational) values and beliefs.”
But while the research on investor attitudes towards responsible investing in Asian suggest a high level of philosophical commitment, the reality is less impressive. oecom comments that “All in all, compared with Europe and the US and given the economic strength of countries such as China, Japan and South Korea, the volume of sustainable investments in Asia falls far short of its potential.” So the question is, do you regard sustainable development as a fundamental aspect of your investment policy and business management? BM