13 Apr Responsible Investing (RI) explained.
One thing I am sure of is we all have a keen eye on the future with hope in our hearts that when Covid-19 passes; and it will, things will be different. I am also sure that one thing that will be different is mankind’s attitude to doing what is right. The overwhelming legacy of Covid-19 will be peoples’ kindness and concern for others and this comes hot on the heels of the younger generation’s recent highlighting of the path of our planet’s journey to environmental disaster unless we change our ways, and we are and we will. One trend in this regard will be the continued growing interest at a faster pace in Socially Responsible Investing (SRI).
There is over €500 billion spread across 2,816 investment funds per a recent KPMG report amongst European based fund managers which have what is described as an SRI theme, sometimes shortened to Responsible Investing (RI). When you look more closely at these numbers and the recent trends, the amount of money and number of SRI funds is increasing substantially each year. Within SRI, there are two main approaches that a fund manager can take to better manage risk and generate sustainable long term returns.
- For the investor who wants the most personal investing approach regarding their own ethics and morals there is an approach called ethical investing. This is very similar to SRI with only a few small factors making them different. The main difference is that in SRI there is normally a set of guidelines that is applied to the entire portfolio. With ethical investing the entire portfolio is filtered through the investor’s personal ethical principles.
- The second approach applies one overarching set of guidelines regarding the selection criteria for stocks to be considered for the portfolio. Often this approach can include an exclusion mandate against certain business sectors because of their links to tobacco, alcohol, gambling, exploitation, weapons and fossil fuel consumptions for example. On other occasions, reaching high standards can be the basis for inclusion on areas such as community development and philanthropy, staff welfare, governance, conservation and environment policy and reporting.
- There is a third approach which is implementing environment, social, and governance (ESG) factors as a basis for selection criteria, and this ESG rating system reviews how a company measures up in terms of its perceived impact taking account of the ESG.
Defining ESG:
ENVIRONMENTAL: Company’s long-term impact on environmental issues such as climate change and pollution. This means that a company which has a high quality system in place to deal with, for example, waste management and control will have a better ESG rating than the company that doesn’t have a proper policy in place for waste management and control.
SOCIAL: Factors like human rights, stakeholder relations, financial support for dealing with social issues, and looking forward to possible regulations that might constrain profit growth for the betterment of social issues are all key determinants of how well a company will score in this regard.
GOVERNANCE: How the company is governed is very important and if this is done fairly and effectively through its board of directors, the company’s track record is likely to be better and stronger from a regulatory and compliance perspective, which should help minimize scandal and poor reputation.
The ESG label is arguably becoming the standard label for mindful investing. When the ESG rating is being implemented into a fund’s SRI approach there are some things to watch out for. Right now, the ESG ratings are not standardized across all providers of ESG data. This just means that funds still need to do their own research to justify the rating companies are given, and therefore an element of subjectivity can creep in.
ESG rating is not the only focus of SRI and neither is ESG rating a barrier that prevents some funds from looking at a possible investment. There are times when a SRI fund may look at an investment that has a low ESG rating and see evidence that the company is making big strides to fix some of the reasons why they have a low rating. If a fund manager makes this subjective assessment, s/he may want to invest because they are taking the right steps to innovate and better their company.
Funds can also take a different approach to SRI and choose to focus on one theme only. The most popular currently is to take a themed approach revolving around the environment. This might mean a fund manager will create their portfolio of investments around companies that are making an effort to limit their companies’ contributions to climate change or are actively working to fix climate change. This can be applied to any themed approach not just for environmental issues.
There are important differences to point out between a fund that relies on ESG and one that solely does SRI. The main difference comes in their overall goals. With a SRI responsible investing fund, they are first and foremost going to adhere to the mandate regarding the investment themes to avoid. This makes the fund more of a personal value driven fund. Funds that use ESG however are more likely to be more financially driven first with the ESG factors coming second to maximizing financial returns.
Depending on the fund manager that you choose for SRI they will most likely have their own standards and rules surrounding which stocks they are willing to invest in. Many SRI fund managers will exclude certain areas of the business world and not invest any money in companies within that area of business. Some examples of exclusions are companies involved in the production of ammunition, guns, landmines, and cluster munitions.
These are just a few of the many things that different fund managers may decide not to invest in. These areas can also involve things like the environment and climate control as well. Many fund managers will not invest in companies based on their environmental footprint. For example, a fund manager may say they will not invest in companies that are working in the thermal coal industry. They can extend it also to say they do not want to work with companies that have not moved for example half of their energy usage away from thermal coal for example. This is a way to be making a social impact at little cost as you are only eliminating a small portion of the options for investment on the market.
SRI at its core takes investing which is normally something with only the one goal of increasing your initial investment and adds a second important goal to that. SRI has the goal of making a social impact by only funding companies that are working for specific goals to fix issues prevalent across the world today. They also have the regular goal of creating value in your investments for both short- and long-term investments.
SRI will become more compelling for us as investors when we consider that based on all studies done on returns for SRI versus a regular investing fund the returns are reported as being immaterially different. People involved in SRI based on the numbers are not making any more or any less money than someone invested in a regular investing fund with no restrictions. And some will argue that in fact, ESG theme funds will deliver superior investor value in the medium and long term and my opinion is that ESG will deliver sustainable investor value.
Finally, I will leave you with this. In a recent interview Gene Murtagh CEO of Kingspan PLC gave in Feb 2020 about his company’s financial results, the conversation shifted to non-financial matters and the company’s impact on the environment. Murtagh explained that his company is experiencing a significant increase in new investors and fund managers with ESG focus, and this is linked to Kingspan’s capabilities as a Zero Net Energy consumption company, which means what it says, its energy requirements are self-generated i.e. the consumption of energy onsite is equally offset by the energy created on site to supply its energy needs, signaling high energy efficiency capabilities and low adverse environmental impact. Murtagh underlined the company’s capabilities when he mentioned that Kingspan received an ‘A’ rating from the global Carbon Disclosure Project (CDP) in recognition of the company’s achievements to cut emissions and develop low carbon business, continually lowering its negative impact on the environment. You see Kingspan are taking its Corporate Socially Responsibility (CSR) seriously, and now actually it is having the desired effect, generating greater interest in its company’s investment potential, and driving shareholder value, and so it goes, the circle for shareholder value is complete in the best possible way.