A considerable range of possibilities and options exist within the responsible investment (RI) universe. And today, given the environmental, social and governance (ESG) tools available, the scope is there to potentially match the full breadth of investor expectations, across all primary asset classes.
The development of the RI universe, enabled by these tools, offers different levels of approach, from ESG-embedded, through to integrated and ultimately impact investing. But given the options available careful assessment of what provides the closest fit to an investor’s needs is required but there is no reason why a bespoke RI approach, cannot be achieved for the majority of mandates.
But the most important first step is to gain insight from your RI manager on which approach and products are the most appropriate for your needs. In order to kick-start that journey, we highlight five areas to potentially discuss with your RI manager below:
What level of RI sophistication should I aim for?
Understanding the right level for RI should mean a customised fit, ie, ensuring the best possible outcomes for any investment process. Every investor will need to recognise what that means in terms of their individual expectations as far as RI is concerned, both in terms of financial performance, and ESG criteria.
There are three levels of RI available to investors; screen, integrate and impact. Screening was initially a form of exclusion, in other words eliminating exposure to companies and sectors, which conflicted with investors’ principles but one that now uses ESG scoring to show how a portfolio lines up to ESG risks and opportunities. The integrated approach uses ESG analysis, including the ESG score, and incorporates this information into investment decisions – offering a clear set of choices on risk and opportunity.
Impact investing takes the latest techniques available and refines them to specifically deliver positive change. This highly targeted form of RI investment has historically only been available to private equity players but is now moving into the public market space.
For each asset class, equities, fixed income, alternatives and real estate, it’s now possible to undertake an RI approach. Each can address how fund managers can have a different read on ESG factors, meaning most approaches can be catered for.
Does the manager have a transparent and consistent ESG evaluation framework and can they explain how it is used across the business?
Whether an investment strategy is focused on screening or integration – where a nuanced approach uses ESG scores to determine a company’s long term ability to evolve – assessment analysis for informing investment decisions is critical.
Therefore investors need to ask what assessment criteria and framework is at the heart of a scoring process. This is crucial in developing a rich picture of the future prospects of the companies invested in – in a world increasingly determined by ESG factors.
Core areas for consideration should include assessments of a company’s business model in the context of long term sustainability trends such as climate change, demographics and regulation. These will all influence and shape the way companies conduct business, and highlight the most material ESG risks firm are facing.
Within each of the ESG factors, there are likely to be key themes in each of the ESG pillars. These include resources, ecosystems and climate change (in environment), human capital and business behaviour (in social) as well as board oversight and management quality (in governance). To make this as detailed as possible there should be sub-factors for each, so in the business behaviour category, human rights, business ethics, customer relationships and the supply chain would generally all be considered.
To ensure that the most accurate and material sectoral information is used to populate an ESG scoring framework, a thorough selection of rating agencies and criteria should be conducted. Moreover, investors should consider whether all these elements are being brought together in a clear process over a period that ensures consistency.
What measurement and reporting tools are available so I can see how my investment has performed (on financial and ESG basis)?
Investors should be keen to ask how their portfolio has performed in financial and ESG terms, because both are closely-tied. After all today a significant element of companies around the world, especially those performing well or expected to perform, are valued to a large extent in intangible assets such as patents, brands and reputation as well as customer loyalty, their commitment to the communities they operate in and effective governance structures.
Investors should ask what tools are available that can determine whether investments are simultaneously meeting financial and ESG targets including, among others, their carbon footprint and diversity levels. The aim is to ensure outcomes that are simultaneously meeting financial and outcome-oriented ESG objectives.
Should I invest in a specialist RI fund, or an integrated product?
Deciding on what approach should be taken will depend again on the investment profile required – whether via a specialist fund that solely concentrates on RI themes – or an integrated product that blends RI ideas with other criteria.
Investors should ask managers about the differences between products, and how they recognise which is the best fit for their mandate. The requirement might change as the mandate changes, especially as increasing elements of the integrated approach come into play. These could be driven by different investment approaches such as fundamental investing, in which stock selection is based on convictions and a recognition that long-term investment focus is increasingly shifting from a geographic to a thematic approach. Alternatively it could be through the quantitative investing approach – using advanced modelling techniques, in which new technology and data is harnessed to conduct a deep analysis of company performance.
What impact themes can/should I target?
Impact investing- which focuses on financing businesses and projects that are designed to have intentional, positive and measurable impacts on society, while simultaneously delivering financial market returns, will appeal to those wanting to achieve both those expectations.
By offering innovative new approaches, investor capital can be applied to achieve greater social utility while simultaneously earning market equivalent returns. Specific expectations can be tailored to areas such as health and wellbeing, agriculture and nutrition, environment and biodiversity, climate change, education, livelihood and entrepreneurial support or sustainable housing.
In the example of education, goals might be access to education for an underserved population. The ideal outcomes can be tailored to an investor’s requirements. Critically, outcomes must be specific and measurable with targets clearly identified from the earliest stages to ensure that projects are directed effectively. Any questions for managers should include what an impact measurement framework will look like? How it will be carried out? And of course, what key performance indicators will be employed?
Matt Christensen is global head of Responsible Investment at AXA IM