Your Money, Your Values
Historically, the two main considerations when it came to investing were risk and return. However in recent years investors have become interested in a third factor – aligning their money with their values. Responsible investing is a rapidly evolving approach that focuses not just on earning a positive financial return, but a positive societal return as well.
Environmental, social and corporate governance factors (“ESG”) demonstrated their importance as drivers of value last year, as companies with stronger ESG ratings outperformed in the aftermath of the COVID-19 crisis. At the same time, investor sentiment has evolved as society becomes more focused on achieving positive impact. As such, demand for investments that reflect an investor’s set of values has surged, and is likely to continue garnering interest over time. There are various solutions and approaches that can be taken to integrate responsible investments into your portfolio. The challenge lies in understanding the nuanced differences between their approaches, as well as the opportunities and risks.
Three Main Approaches to Responsible Investing
1. ESG “thou shalt not invest in XYZ”
ESG: “thou shalt not invest in XYZ”. Screens out investments that don’t align with an investor’s values. Analyzes how a company treats the environment (E), how they treat people, be it employees, customers, stakeholders or their communities (S= social), and how the company is run from a leadership standpoint (G= governance). An ESG portfolio will then exclude investments that do not contribute positively to these three areas.
2. Socially Responsible Investing (SRI): “thou shalt only invest in XYZ”
Socially Responsible Investing (SRI): “thou shalt only invest in XYZ”. More intentional than ESG, about inclusion not exclusion. SRI focuses on investments that are positively impacting the world.
3. Impact Investing: “thou shalt only invest in XYZ and achieve measurable impact”.
Impact Investing: “thou shalt only invest in XYZ and achieve measurable impact”. The most intentional and specific kind of responsible investing. An impact portfolio will rank underlying investments based on their impact score, and seek measurable, quantifiable alignment with positive outcomes.
Opportunities of Responsible Investing
The potential to positively impact the world is of course a key opportunity. The ability to direct resources in this way can be inspiring and empowering for investors – a needed solution in an industry that has historically prioritized financial return. Yet at its core, responsible investing revolves around the notion that doing good is often what’s good for business, and as a result, good for investors as well. Essentially, companies who “do good” can be considered less volatile or risky, because companies who do not prioritize the environment or social issues are more prone to getting hit with fines or financial losses related to their problems. Evidence has shown that responsible investments can in fact help mitigate portfolio risk and enhance long-term returns.
Risks/Challenges of Responsible Investing
One challenge that the responsible investing industry faces is greenwashing – when an investment leads you to believe it is doing more good than it really is. Similarly, another challenge is the lack of universal rating methodology for the space. A study from Fiera Capital revealed that correlations between major ESG rating methods are quite low. This does not mean that the ratings are necessarily unreliable, but it does indicate that they are different, and that the industry could benefit from greater standardization.
Myths of Responsible Investing
The performance tradeoff myth is definitely the most entrenched misconception about the space. A 2015 meta-study of over 2,200 pieces of academic work over 40 years analyzed the relationship between financial performance and ESG factors. They found that in 90% of the cases studies, companies with strong ESG profiles either matched or outperformed their traditional counterparts. For investors that are interested in the space, know that it does not mean you have to leave money on the table.
If responsible investing interests you and you are not sure where to start, please do not hesitate to reach out to an advisor at Kerr who can help align your values with your investments.