Sustainable investing has captured the attention of institutional investors worldwide, but understanding what to do about it is more challenging. There’s a range of solutions to meet your sustainable investing objectives. These are very different strategies, and asset managers will typically have comparative advantages for each strategy type.
Investors can bucket sustainable investing strategies into two broad categories: exclusion and integration. Exclusion strategies apply negative screens to avoid certain business activities. Integration strategies incorporate ESG factors explicitly and systematically in investment decisions to deliver targeted outcomes.
Selecting investments by specific criteria has historically been the most widely used form of ESG investing. There are typically two types of screening: values-based and norms-based. Values-based screening avoids investing in companies based on specific business activities, industries, or geographic areas. For example, religious organizations may seek to avoid ’sin stocks’ – companies engaged in gambling, tobacco, alcohol, or pornography. Norms-based screening excludes companies that do not meet internationally accepted “norms,” such as the UN Global Compact, Kyoto Protocol or UN Declaration of Human Rights, etc.
ESG integration is the systematic and explicit incorporation of material ESG factors into investment analysis and investment decisions. Relevance to investment performance and risk drives ESG integration. 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.
Once a manager integrates ESG factors, investors can seek one of four targeted outcomes: best-in-class, positive-tilt, thematic, and impact investing. Best-in-class strategies invest in high relative stock-level ESG scores and avoid ESG laggards. Positive-tilt strategies target high relative portfolio-level ESG scores yet may include low relative stock-level ESG scores. Thematic approaches invest in stocks that support broad ESG themes such as clean energy. Finally, impact investing attempts to make a positive impact on environmental and social issues.
All strategies may or may not practice active ownership/stewardship, which positively influences corporate behavior on ESG-related issues. Shareholders can influence companies through direct dialogue or voting rights to improve 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 ongoing process and not a one-time event. Investors can engage individually or by pooling efforts collectively, which may increase influence. Many governments worldwide encourage engagement through stewardship codes that encourage institutional investors to be active and engage in corporate governance.
A Sustainable Future Requires More
ESG investing and active ownership/stewardship are two of the four components that Intech considers necessary to truly practice sustainable investing. You can learn more about sustainable investing by downloading Intech’s 5-minute Primer on Sustainable Investing. It provides quick, direct answers to basic questions about sustainable investing:
- What is sustainable investing? Is it different from ESG?
- Why do institutional investors adopt ESG criteria?
- What misgivings do investors have about ESG?
- How do you invest in a sustainable future?
Download the guide today!
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