Socially responsible investment
Eileen Rowsome
Senior Investment Analyst
Responsible investing, the good, the bad and the admirable
Some might say that 2022 was the year of reckoning for responsible investing. Performance struggled given the inherent lack of exposure to commodity heavy sectors (such as non-renewable energy e.g. oil) which, due to global shortages, outperformed significantly in the year. Debates around exclusion of certain sectors like weapons came under scrutiny because of the war in Ukraine and a nation’s right to defend themselves. We’ve also seen many politically charged headlines about the backlash towards asset managers for being more vocal about responsible investing, much to the distaste of some US states.
Figure 1: Sector performance variation over 2022
Source: Morningstar at 2nd December 2022
On the positive side, and despite the backlash, we have seen a shift in rhetoric from many large investment firms to set net zero ambitions, who are in turn looking at the companies they invest in to do the same. Diversity, equity, and inclusion is a topic that is discussed not just by staff but by shareholders who want to be investing in companies with fair and equitable employment practices. I also believe that the debate and inconsistencies highlighted in recent years by naysayers will only move to improve standards and communication.
291 signatories with USD 66 trillion in assets under management have signed up to the to net zero asset managers initiative
Issues with jargon
The responsible investment industry hasn’t helped itself in recent years with the endless array of acronyms and approaches, from ESG (Environmental, Social & Governance) to SRI (Socially Responsible Investment) and Impact. This issue has been compounded to a certain degree by recent regulation that has introduced more terms and more dreaded acronyms, be that SFDR, Article 8, EU Taxonomy*. The confusion all this has created is worthy of criticism but overall should be welcomed to help drive improvements as the industry matures as these terms need more concrete explanation.
Growth towards better outcomes
The spirit of the new regulation, however, is admirable as are most investors motivations when investing in the space. The regulation aims to direct more capital into sustainable investments benefitting all stakeholders, not just shareholders. It does this whilst also aiming to provide more clarity and transparency to investors on what 'good' looks like when it comes to a sustainable approach.
As with many things in finance, the industry evolves before the structure of standardisation and regulation comes in. This is good for innovation but not so good for investors, who are not involved in the day to day, to understand what they may be investing in. As the regulation beds down, it should meet its aim of standardisation and transparency too.
Our approach at Davy
We use the term Socially Responsible Investing when referring to a more socially conscious approach to investment activity that puts the method of investment on par with the financial outcome measured in risk adjusted return i.e., the ‘how’ we invest is as important as the ‘why’. We believe this is an appropriate term as it encompasses the key areas of an investment approach namely:
- exclusion on harmful activities and products
- integration of environmental, social and governance (ESG) factors into investment analysis
- engagement to affect change
- measuring impact
For fear of consigning myself to the band of acronym junkies, I’ll refer to the activity as this approach as responsible investing throughout the rest of this article but note it can also be referred to as SRI.
While a base level of exclusions is necessary to avoid harm (think tobacco, human rights violators), thankfully the market has moved on in recent years from focusing on exclusions only, to assessing the risk and opportunities ESG factors represent to an organisation as well as how their products and services contribute to a greener, safer, and more equitable world. In addition, engagement to improve laggards is increasingly coming the fore. By encouraging all companies and countries to improve practices, responsible investing will really meet its non-financial aspirations.
But what are these ESG factors I mention?
Environmental, Social and Governances factors are important considerations when looking at the operations of an individual company or country. This could be assessing the carbon footprint of a company, its labour practises or how company management are incentivised. ESG factors may be considered in a traditional investing approach also, but their importance is given a higher level of consideration with a responsible investing approach.
Sustainable investing is another term used quite widely. For us, the focus here is more on the products and services provided by companies and countries and what needs they might meet. This type of approach can have a narrower scope for investments, particularly under new EU regulation, but there are also some exciting thematic developments here. For example, energy transition investment funds, that look to invest in companies aiding the energy transition, may have a high carbon footprint now but the change they can affect will be noteworthy.
It would be amiss of me not to touch on the performance debate.
Does a responsible investment approach lead to a better financial outcome?
In theory, investing in companies and countries that are repositioning themselves for a more sustainable world should do well in the long term, but it shouldn’t be seen in isolation without a traditional assessment of what makes an investment attractive.
In practice, it really is too early to tell. There are numerous indices out there that show returns superior to the market for various responsible investing approaches, but caution should be exercised when looking at these. Many indices with a responsible investing angle have been created in recent years, and while they may show years of history, this is a hypothetical or back test of returns rather an experienced return.
There will be times when a responsible investing approach outperforms, like in 2020 and when it underperforms, like in 2022. For investors the key question is whether they believe investing in companies which are contributing to or changing to contribute to a greener, safer, and more equitable world is aligned with their financial and non-financial aspirations. It should be noted however, that progress is not linear, and there will be times, like this year, when patience is needed.
*SFDR: Sustainable Finance Disclosure Regulation. Article 8: Funds filing under article 8 of SFDR are funds that promote environmental or social characteristics.
EU Taxonomy: classifies economic activities as either environmentally sustainable or not.
Warning: Past performance is not a reliable guide to future performance. The value of your investment may go down as well as up. These products may be affected by changes in currency exchange rates.
Warning: Forecasts are not a reliable indicator of future performance.