What are ethical, sustainable, ESG and impact investing – and how do they make a difference?
[CB1] Ethical and responsible investment is booming.
Statistics tend to vary but by some measures the scale of sustainable investment is now well into the hundreds of billions. Recent data shows a 73% increase in assets managed according to environmental, social and governance consideration between 2012-2016 with over $22 trillion in assets under management by the end of this period. [CB2]
But what do we mean by ethical, responsible and sustainable? What is driving the growth in these ways of investing? How can private individuals invest their ISA, pensions and other savings in pressing themes like climate change adaptation and resource efficiency?
Once a niche, now a hot topic for all
More than two decades have passed since the first ‘ecology’ and ‘ethical’ funds launched back in the 1980s and what began a niche investment topic is now much front and centre of general investment discussions. I have spent most of my career working in responsible and ethical investing and never before has there been so much interest. So what is driving this?
There are a number of forces at play. Very large sovereign wealth funds like Norway’s Pension Fund and major Dutch and US pension schemes are moving a lot of capital into sustainable investments, often due to concerns arising from mounting evidence of climate change impacts and a resultant need to reduce risk.
In the UK, the National Trust has just announced plans to move its investments away from fossil fuels and other environmentally harmful activities. The National Trust ‘fund with over £1bn in assets will divest from mining, coal and oil over the next few years.
As more and more high-profile organisations make the link between money and real-world social and environmental impact it seems that more and more individuals are making this connection too.
There is a lot of discussion in the investment industry around how the next generation of investors are far better informed than their parents about environmental and social issues like pollution, climate change and education and this is driving innovation and change in the market.
What are the practical options for individual investors?
The good news is there are lots of options to consider, with most investment companies now offering at least one ethical or sustainable investment option. However, making sense of these options can be quite difficult, so here is my short guide to the main types of funds on offer.
Firstly, there is "screened" or ethical investing - these are funds which exclude specific activities such as investments in tobacco companies or weapons manufacturers. A good quality negatively screened investment fund will set out clearly and concisely the types of companies it cannot hold. Many of these funds will employ and external oversight committee responsible for evaluating the ethical screens in place.
Examples of ethical funds are Kames Ethical Equity, Kames Corporate Bond and Lion Trust’s Ethical Fund.
Secondly, there are sustainability funds – these typically take a thematic approach to investing, identifying economic sectors or trends which make a positive contribution to society and the environment. It’s best to understand this style of investing by focusing on an example of a typical theme. For example, energy efficiency is a theme that focuses on the drive to use less energy in homes and businesses as we all attempt to reduce CO2 emissions. The theme also saves money - never a bad thing! Other examples of themes could be around water scarcity and increased urbanisation and waste management. So these funds will seek to identify high quality (profitable, growing businesses) actively exploiting these themes.
Example of funds in this category are: Impax Environmental Markets and WHEB’s Sustainability Fund.
The next most widely discussed form of responsible or ethical investment is a more recent development referred to as Impact Investing. The origins of this style of investing come from within private equity and institutional investment markets where a higher level of investment sophistication (and cost) can lead to a far more tailored approach to investing. The focus with Impact Investing is on measureable social or environmental outcomes, so impact investment products often have very specific social and environmental outputs. This style of investing is well suited to green bonds or other forms of fixed interest securities where it is possible for investors to draw a relatively simple line between their investment and a defined impact.
Finally, we have ESG Funds. This is a style of investing that incorporates environmental, social and governance data into investment decisions and is a growing part of the market as major investment organisations like UBS move to offer their clients a ‘sustainable investment’ solution. What makes this style of investing especially complex is that it’s not always possible to deduce where the emphasis is being placed; on the ‘E’ the ‘S’ or on the G? This can lead to some curious outcome from an investor perspective with companies not normally associated with sustainability being included in portfolios[CB3] .
Individuals or organisations considering an investment should take advice from a suitably qualified or regulated individual.
Glossary – some useful terms to help guide you through Sustainable Investment
Fund - A collective investment scheme offering a group of investors access to a particular style of investment via one single share or in some cases unit.
Sustainable- The Brundtland Report ‘Our Common Future Report’ defines sustainability as development which does not impair the ability of future generations to meet their needs whilst still meeting the needs of the present generation.
Ethical - Investment decisions based on personal moral choice.
Responsible- Investment which considers a broader range of concerns outside of conventional investment analysis.
ESG- Environmental Social and Governance investing.