Everything you need to know about sustainable investing
We clarify what some of the commonly misunderstood sustainability terms mean.
Sustainable investing continues to soar in popularity.
Net flows into sustainable funds in the US reached $20.6 billion in 2019, for example. That’s more than four times the previous annual record, which was set in 2018.
However, investors are confronted with a litany of terms, acronyms and conflicting definitions. Andrew Howard, Global Head of Sustainable Investment at Schroders, says: “It’s critical that we demystify some of the terminology that causes confusion among investors.
“As sustainable investing becomes more mainstream, it’s important that investors understand the different approaches available so that they can make the right choices for their individual circumstances.”
We’ve put together some explanations of the main strategies below.
ESG integration is a general approach to investing that incorporates environmental, social and governance (ESG) considerations into the investment decision alongside traditional financial analysis.
Broadly speaking, environmental factors include issues such as climate change, deforestation, biodiversity and waste management. Social factors include issues such as labour standards, nutrition and health and safety.
Governance includes issues from company strategy to remuneration policies and board independence or diversity.
ESG integration is about understanding the most significant ESG factors that an investment is exposed to, and making sure that you’re compensated for any associated risk.
Although sustainable investing involves ESG integration, it takes things further by focusing on the most sustainable companies that lead their sector when it comes to ESG practices.
Both the ESG integration and sustainable investing approaches are about engaging with company management to make sure the firm is being run in the best possible way.
This could mean challenging a company on its sustainability practices to encourage improvements where necessary.
Screening is when you decide to invest, or not to invest, based on specific criteria.
For example, if an investor only wants to invest in companies that promote workplace diversity, one of the criteria might be substantial representation of women and minorities in management-level positions. Or it could be the existence of diversity and inclusion policies.
These factors are used to deliberately exclude investments that don’t meet these criteria (negative screening) or to purposefully include those that do (positive screening).
Ethical investing is an example of where screening is commonly used.
Investors screen out investments that they deem unethical because they don’t fit in with their ethics or values. It’s also called values-based investing.
People commonly exclude so-called “sin stocks” such as alcohol, gambling, weapon manufacturing, tobacco or adult entertainment companies because they view these activities as immoral.
Impact investing is about putting your money to work in a way that has a specific, measurable and positive benefit to society or the environment.
Many investors use the UN Sustainable Development Goals as a framework to guide their impact investing.
The 17 goals represent the biggest challenges facing the world today. Although they are aimed mainly at policymakers rather than investors, aligning to them is a way impact investors can contribute towards solving key global problems.
Impact investing isn’t to be confused with a charitable donation, though. You also want to generate a return on your investment as well as promote social good.
This is about investing according to a chosen investment theme.
For example, an investor with a “health and wellness” focus will likely only consider funds that invest in healthy food brands or those companies focused on developing new vaccines.
“Green” investors will likely only invest in companies and technologies that are considered good for the environment – alternative energy generators or energy-saving technology manufacturers, for example.
The above is not an exhaustive list of the sustainable strategies available. It should serve as a good starting point to help investors understand the differences between some of the common approaches.
“Clarity and specificity are more important than ever, but so is the ability to assess whether your investment is doing what it says on the tin,” Andrew says.
He adds: “Measuring and monitoring investments from a sustainability perspective is a challenge that many investors face. Reporting on sustainability factors in a meaningful way is a vital step in the process".
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