Consideration of environmental, social and governance issues has captured the attention of institutional investors worldwide, but understanding what to do about them is more challenging.
To cut through the puzzling array of acronyms and definitions, we group ESG investing into four broad categories based on Global Sustainable Investment Alliance (GSIA) definitions.
Assets in this table are double-counted because the four categories are not mutually exclusive.1 Managers may employ multiple approaches, such as positive screening and active ownership. The appropriate approach or combination of approaches is not the same for all investors. Asset owners with a particular set of beliefs, resources and needs will embrace ESG considerations differently. Most importantly, investors need to consider the quality and depth of each application.
Selecting investments by specific criteria is the most widely used form of ESG investing. There are typically two types of screening: 1) negative or exclusionary screening which excludes or underweights investments from specific companies; and 2) positive screening which only includes or overweights investments with higher ESG ratings.
A screening variant that sets minimum standard business practices based on international norms is known as norms-based screening. These screens may set investment restrictions for adherence to human rights or perceived moral behavior. For example, religious organizations may seek to avoid ’sin stocks’ – companies engaged in gambling, tobacco, alcohol or pornography.
ESG integration is “the systematic and explicit inclusion of material ESG factors into investment analysis and investment decision.”2 ESG integration is driven by relevance to investment performance and risk implications in asset selection and portfolio construction. While ESG integration is often associated with fundamental strategies, it is also in the toolbox of many quantitative managers who enrich their financial datasets with data on ESG factors.
Active ownership is a process by which investors positively influence corporate behavior on ESG-related issues. Shareholders can influence companies through direct dialogue or through voting rights with the objective of improving a company’s policies, practices and disclosures.
Aligning active ownership practices into investment decisions is not an easy task. Engagement should be thought of as an on-going process and not a one-time event. It can be conducted by investors individually or collaboratively, which can increase effectiveness. Many governments across the world encourage engagement through stewardship codes which encourage institutional investors to be active and engage in corporate governance.
Impact investing is the fastest-growing type of ESG investing although it’s the smallest category in dollar terms.3 Impact investing directs capital in private markets to generate environmental or social benefits while delivering strong risk- adjusted returns. Sustainability-themed and community investing are related terms for this type of investing. Examples of these investments include clean energy, green technology or sustainable agriculture.
A variety of approaches for incorporating ESG considerations into investment portfolios has emerged. Integration complements an investor’s pursuit of better financial outcomes by including ESG criteria in the investment process. Active ownership can amplify investors’ voices and increase the impact of their votes to bring about positive change. Screening securities based on specific business practices supports asset owners’ values and can also impact corporate behavior. Even private markets can be influenced through impact investing.
Learn more about the opportunities that exist for asset managers to offer better tools, information and education on ESG investing, and download our no-nonsense primer on ESG investing: Invest in the ABCs of ESG.
1 Intech calculations using reclassified data from Global Sustainable Investment Alliance 2018 Report. GSIA data include some double counting of assets. When subtracting double-counted assets, GSIA estimates are $30.7 trillion market size. CAGRs are the four years ended 2018.
2 Source: Principles for Responsible Investment (PRI).
3 Source: Global Sustainable Investment Review 2018, Global Sustainable Investment Alliance.
This information is intended to be educational and is not tailored to the investment needs of any specific investor, nor is it an endorsement or recommendation for any particular security or trading strategy. You should not rely on this information as the primary basis for your investment, financial, or tax planning decisions. Past performance cannot guarantee future results. Investing involves risk, including the possible loss of principal and fluctuation of value. All content is presented as of the date published or indicated only, and may be superseded by subsequent market events or for other reasons.