Sustainability is a key discussion point across the globe, but how is it used in investing and could it help your portfolio?
The Rise of Responsible Investing
What is it?
Responsible investing is largely thought to be the incorporation of environmental, social and governance (ESG) factors into the decision-making behind the investment process. A landmark study in 2005 entitled “Who Cares Wins” saw the term ESG coined for the first time, and laid the foundations for further publications and initiatives allowing responsible investing to evolve into the phenomenon it is today. The release of this report materialised after then UN Secretary-General Kofi Annan wrote to the CEOs of 55 of the world’s leading financial institutions in 2004, inviting them to join the initiative for making financial markets stronger and more resilient whilst also contributing to sustainable development.
ESG factors span across a wide range of issues which traditionally don’t constitute part of financial analysis yet may have financial relevance. Examples of these might include how businesses deal with climate change, especially through waste disposal and water usage, how good their health and safety policies are at mitigating accidents, how they respond to human rights issues within the company and throughout the supply chain, how workers are treated, the structure and compensation of the board and how accountable they are for company performance. The list goes on, and is one which will forever be growing and developing.
How big is it?
ESG investing is continually growing in significance and magnitude amongst both retail and institutional investors. It can be related to a movement which has been practiced since the 1960s, called Socially Responsible Investing, whereby investors excluded stocks or entire industries due to business activities such as tobacco production or links to the South African apartheid regime. Earlier this year the Global Sustainable Investment Alliance released their 2018 review, indicating sustainable investing assets in the five major markets stood at $30.7 trillion at the start of 2018, growing by 34% in two years. Europe continues to manage the highest proportion of sustainable and responsible assets, accounting for nearly half globally. Impressive growth from Japan and consistent growth in the US has seen their share of the pie increase. The graph below illustrates the growth of sustainable and responsible investing in the US alone. In terms of strategy, ESG integration comes second only to negative/exclusionary screening on a global basis and is estimated to cover $17.5 trillion of assets, growing by over two-thirds in the past two years.
The world’s leading proponent for responsible investment, the PRI (Principles for Responsible Investment) is a UN-backed, global initiative with the aim of advancing the integration of ESG into analysis to enhance returns and better manage risks. Today, it has over 2300 signatories (organisations representing the holders of long-term retirement savings & investments) and spans across a total of $86.3 trillion worth of assets. Despite the rapid growth of ESG investing into the mainstream, the rise of it has not been smooth with many questioning its link to improved returns.
What does it mean for investors?
Much debate has been centred on whether or not ESG investing aids performance. A number of studies suggest companies fully embracing ESG practices tend to exhibit a lower cost of capital, lower volatility and fewer instances of fraud, bribery and corruption. In contrast, others suggest the evidence of ESG adding value is less than concrete due to the complex and ill-defined nature of the potential factors. It has also been argued ESG factors could increase an investment portfolio’s risk due the reduced diversification potential that arises with a smaller investment universe. In reality, these arguments are becoming less and less relevant due to greater awareness and the adoption of ESG beliefs becoming increasingly focussed on allocating capital for positive impact. In 2015, a vast meta-study which aggregated more than 2000 empirical studies relating to ESG and financial performance found a positive relationship between ESG and corporate financial performance. The research concluded the orientation toward long-term responsible investing should be important for all kinds of rational investors in order to fulfil their fiduciary duties and may better align investors’ interests with the broader objectives of society.
BMO can be deemed as one of the leading players within the field of Socially Responsible Investing (SRI) due to their large Governance and Sustainable Investment team and the Independent Committee of Reference. The investment process favours companies promoting sustainable development and making a positive contribution to society. Negative screening is also applied to avoid certain unsavoury companies and sectors. The fund aims to provide capital growth by investing in an actively managed portfolio of ethically screened, diversified global equities.
The fund’s SRI investment approach forms the core of the overall strategy. The team takes steps to identify attractively valued, responsible and sustainable businesses that will benefit or provide solutions to one or more key themes in: better resource efficiency, improved health and greater safety & resilience. Use of the Sustainability Matrix helps to analyse a company’s core business, product sustainability and management quality. This is all overseen by the Advisory Committee to ensure consistency is upheld and guidance on the suitability of holdings is given. The fund represents a viable option for investors seeking a mixed asset solution with a relatively strong preference towards equities.
This investment grade fund targets high yield with a strong ethical overlay. Once investment themes have been developed, the team carry out credit analysis to find the assets which work best within the thematic framework. Cash flow and strong balance sheets are key in determining bond selection, The ‘Plus’ is conviction – that to achieve above average long-term performance, the team feel they must think differently to the market. After that, an ethical overlay is applied which consists of a negative screening followed by a positive screening. Input from Rathbones Greenbank makes good use of this specialist ethical resource within the group. This fund is suitable for SRI investors particularly seeking income over capital growth.
All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.