The pandemic has accelerated a longer term shift to responsible investing. Square Mile looks at how the investment industry is adapting.
The ongoing Covid-19 crisis has prompted a widespread reassessment of how we live our lives – from healthcare and economic wellbeing to our everyday activities and the impact they have on society or the environment. This re-evaluation has extended to investments, as investors seek to understand how their money can be used for the greater good and consequently, flows into responsible funds have surpassed expectations throughout this extremely volatile period. However, these trends are not new to the industry, with the pandemic merely accelerating a shift in mindset that has been gaining momentum for a while.
Driven by a combination of greater investor awareness and regulatory pressures, all corners of the asset management industry are working hard to keep up with this rapid evolution. ESG analysis is now being incorporated across fund groups and new strategies are being launched to meet the demand. However, as with any new investment approach, there is still widespread confusion and misinterpretation.
One of the biggest challenges the industry faces when it comes to ESG integration and responsible investing is the use of consistent terminology, particularly when articulating these approaches to clients. This area has proven to be quite subjective, with different interpretations being applied across the market. Although ESG and responsible investment are interlinked, they are distinct – with the analysis of ESG forming part of the fundamental input into the investment process, whilst responsible investing is the concept of actively trying to use investment as a way of creating better outcomes beyond a monetary objective.
“One of the biggest challenges the industry faces when it comes to ESG and responsible investing is the use of consistent terminology, particularly when articulating these approaches to clients.”
Responsible investing is the umbrella term used by the Investment Association to cover all forms of investment that involve social and environmental considerations. Investment can be viewed as a spectrum of approaches by which capital is put to play; at one end there is traditional investment which primarily focuses on financial returns, and at the other end is philanthropy, where financial considerations are very much secondary.
In the middle of these two extremes is responsible investing, whereby portfolio managers seek to generate a competitive financial return whilst considering social and environmental concerns. However, responsible investing is by no means homogenous. There are approaches which incorporate a sustainability element which seeks to make a direct contribution to a better world alongside monetary objectives. Further yet, impact investing is explicit in its intent to make a positive social or environmental impact, not only demonstrated by a clear implementation of this kind of strategy but by the ability to measure the extent of its impact for good.
Although these approaches are not exclusive of one another, with some strategies adopting a number of these characteristics in their approach, language is important. Clear and consistent terminology is imperative to avoid misunderstanding when articulating these approaches to clients. However, this is only one piece of the puzzle: there are a number of other misconceptions surrounding responsible investing which may only add to the confusion.
One of the most common of these is that of performance, with the traditional view being that investors are faced with a binary decision between returns and incorporating social purpose into investment. A look back over 2020 can quickly debunk this enduring myth, as the ongoing Covid crisis has demonstrated the resilience of funds with a sustainable or responsible mandate throughout a period of extreme volatility. Although this is a relatively short term view, when comparing like for like over the longer term, funds which encompass responsible investing consistently deliver comparable or better returns than their conventional equivalents.
This is no coincidence, and there is good reason for these returns. Traditionally, responsible investment funds tended to just avoid ethically unacceptable companies which resulted in a smaller universe of stocks to choose from. However, this is no longer the case. Instead, they now embrace positive solutions which open doors to investment opportunities. There is no doubt the world is facing major challenges, from climate change and food pressures to diminishing natural resources. There are multi decade opportunities which not only avoid the headwinds of environmental legislation, regulation to limit climate change and reputational risk, but create tailwinds for those companies providing solutions to these issues, resulting in higher than average growth prospects. Investors are no longer faced with the choice between performance and responsible investing: it’s one and the same.
With responsible investing proving to not only be positive for the planet, but also financial wellbeing, the rapid shift to do good across the industry presents a further challenge in the form of greenwashing. Alongside this seismic shift has come a proliferation of funds labelled ‘responsible’ or ‘sustainable’, all claiming to invest positively or with impact but not all delivering on this promise. Whilst the intention to do good and avoid harm is an easily identifiable objective, it is much harder to evidence in practice and unfortunately some funds overplay their credentials in order to tap into this new stream of investors and their money.
There are many good funds across the market that truly invest in solutions to the social and environmental challenges the world faces. Investments in healthcare, renewable energy infrastructure, resource efficiency and social housing can make a real difference. Although there are funds that report on their impact providing transparency for investors who want to quantify the real life impact that their money is enabling, this needs to become the standard.
At Square Mile, we have recently completed the acquisition of 3D Investing, a specialist in the assessment of impact investing. The process driving 3D Investing centres on a fund’s ability to make a positive and measurable environmental and/or social impact as evidenced by its underlying investment. This acquisition further enhances Square Mile’s capability in responsible investing research, which has a broader focus on identifying funds that fall into three categories: exclusion, sustainability and impact. As investors are faced with a plethora of information when it comes to responsible investing, the Square Mile and 3D Investing research processes aim to provide honest and detailed information, outlining exactly what they can expect to achieve from a fund.
There is no doubt the industry is moving rapidly to keep pace with these continually evolving and accelerating trends. The move towards responsible investing has the incredible potential for good, but this can only be truly harnessed if the industry is truly aligned, from consistent terminology and language to the tools and research available to accurately measure and evidence a fund’s footprint.
Jake Moeller, Senior Investment Consultant, Square Mile
Article taken from Hub News Issue 47.