Financial planning / Investments

Why should socially responsible investing matter?

There was a time when environmental, social and governance (ESG) issues were the niche concern of a select group of ethical or socially responsible investors who tended to have very strong views – but times have changed. Charlie Buxton, our Portfolio Manager, shares some thoughts on why ESG is increasingly relevant and an approach that all investors should consider.

A number of factors have changed the landscape of socially responsible investment (SRI). Growing awareness of environmental issues, such as climate change and an increasing understanding of social issues and human rights have each played their part. As a result, people are increasingly interested in reflecting their opinions and lifestyle choices through the way they invest.

The Socially Responsible Investment market itself has also changed significantly over recent years. Environmental, social and governance factors are now part of mainstream investment analysis. The widely adopted Stewardship Code has meant investment managers have embraced a ‘responsible ownership’ agenda. This in turn is beginning to impact the share prices of more ‘ethical’ companies, a trend which is accelerating, to the benefit of both SRI funds and investors.

Types of SRI approaches

There are four main approaches to socially responsible investing:

Responsible ownership and engagement: This sees fund managers taking greater interest in their responsibility as part owners of companies. Usually, managers open up conversations with companies to explore how ESG areas are being managed, which may (in some cases) be followed by votes against company management at general meetings. The point of all this is to encourage companies to improve their practices in areas where investors believe environmental, social or governance related risks and/or opportunities could be managed better for the benefit of shareholders. This type of approach usually applies to ‘mainstream’ investments that fund managers own and expect to retain. Generally, this tactic isn’t enough on its own to regard a fund as socially responsible, but companies held in such funds generally manage ESG issues relatively well.

Avoidance or negative screening strategies: Avoiding companies that are involved in activities that a fund manager has defined as ‘unacceptable’ or ‘unethical’ is a major feature of ethically screened funds.

Negatively screened ethical funds typically have a list of business practices that are considered to be unacceptable. The criteria which defines a fund to be negatively screened is often connected with values-based ethical issues, but may also relate to environmental, social or governance concerns. If you are looking to be socially responsible, a key problem with this approach is that the impact on investment strategy varies significantly from fund to fund. Some funds exclude companies with only minor involvement in excluded activities whereas others are less strict and balance the positive benefits of companies against their negative attributes. We tend to class a portfolio including these types of funds or investments as “Light Green”.

Positive screening strategies: This approach involves investing in companies that meet a manager or fund’s ‘positive’ SRI objectives. A fund manager may set out the themes or business attributes it considers to be positive, beneficial or desirable – such as helping us to make the necessary shift towards more sustainable lifestyles – and invest accordingly.

Some funds focus on a single sector or issue, although most are broad-based – focusing on a range of longer-term challenges and opportunities that face businesses. Some invest in a narrow range of industries; others invest widely in companies that achieve certain standards. Themed funds such as Environmental funds and Sustainability funds generally have positive approaches of this kind. We class a portfolio including these types of funds or investments as “Green”.

Impact investment strategies: Impact investing aims to generate specific beneficial social or environmental effects in addition to financial gains. The point of impact investing is to use money and investment capital for positive social results. Impact fund managers aim to place capital in businesses, non-profits and funds in sectors such as renewable energy, basic services (including housing, healthcare, and education), micro-finance and sustainable agriculture.

Impact investing happens across both geographic markets and asset classes. For example, it might focus on private equity/venture capital, debt and fixed income in developed and emerging markets. Depending on the goals of the investors, you can target a range of returns from below-market to above-market rates. By its very nature impact investing tends to direct capital to smaller companies and so is typically regarded as higher risk. A portfolio including these types of funds or investments can be classed as “Dark Green”.

Typical SRI issues

There are a range of issues which it’s useful to take into account when considering an ethically sound portfolio. These include:

Environmental issues: encompassing a range of challenges such as climate change, pollution, fracking, biodiversity, environmental management, waste and the use of natural resources – including water, forestry and mining.

Social issues: including human rights, labour standards, child labour, equal opportunities, food supply, obesity and slavery.

Governance issues: relating to company management, board structure, executive remuneration, bonuses, avoidance of bribery and corruption.

Values-based and ethical concerns: including tobacco, armaments, pornography, alcohol, irresponsible marketing and animal welfare.

The way in which issues and approaches are combined varies greatly, and there are now a wide range of options available. The issues that are important do vary and change over time. For example, e-cigarettes, fracking and Arctic drilling are emerging issues that are now being considered by some managers.

Likewise, there are no hard and fast rules about how different funds or fund managers are grouped together. In fact, they can be sorted into a number of ‘SRI styles’ based on their approach to ethical, social and environmental issues.

Find out more about ESG investing

Watch our recent webinar.

Webinar – ESG Investing

What to remember when considering SRI

It’s important to remember that SRI factors are not the only relevant aspects to consider. Generic factors impact SRI funds as much as they do any other investments. So it’s important to consider asset type, the market capitalisation of the stocks held, geographic spread and timing which can all affect SRI portfolio returns. In addition, think carefully about your own investment aims (growth or income), benchmarking decisions, fund manager skill and charging structures.

SRI investing at The Fry Group

Our SRI portfolios are designed to suit investors who are both financially motivated and driven by specific personal values. In evaluating an SRI fund manager we consider the ‘generic’ and ‘SRI’ factors – as neither offers a complete picture on its own.

We invest with managers who recognise that the management of environmental, social and governance (ESG) issues can positively impact business success.