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What is responsible investing? - DFSIN - SFL

What is responsible investing?

Is it possible to align personal investments with personal values? Here’s an overview of a concept that is gaining traction in the financial world.

June 22, 2020

The exceptional times we are experiencing due to the COVID-19 crisis have helped to shed light on certain flaws in how our societies are organized and what their priorities are. Some investors might be wondering about the possibility of investing in a way that could change things. In other words: investing responsibly.

 

An approach that has evolved over 50 years

While the concept of responsible investment has been around for a long time, it was in the early 1970s that tailored investment products began to appear, notably with the launch of the first responsible investment mutual fund in the United States: the Pax World Fund. In 1990, one of the first socially responsible stock indices, the Domini 400 Social Index, was created, followed a few years later by the Dow Jones Sustainability Indices and a number of others.

A significant milestone occurred in 2006 when the United Nations launched the Principles for Responsible Investment (PRI), offering guidelines for institutional investors committed to taking concrete action through their portfolio management practice. These investors include pension plans and mutual funds. By the end of 2019, the PRI had some 2,500 signatories, whose combined assets under management were approaching US$85 trillion (a trillion equals 1,000 billion).

 

A diversified concept

This doesn’t mean, however, that all of these assets are managed according to the principles of responsible investing, nor that the same responsible investment approach is applied across the board. Indeed, the concept has come to take different forms over the years, ranging from responsible investing to sustainable investing to ethical, socially responsible and impact investing.

On a scale with pure return-seeking at one end and pure philanthropy at the other, all of these approaches can be found somewhere in between. Some of them, such as “impact” investing, actively seek to have a positive effect, while others try to avoid investing in companies that have a negative effect.

 

Three letters, two overarching approaches

As defined by the PRI, a responsible investment approach must factor in three types of issues, known by the acronym ESG:

  • environmental (climate, resource depletion, deforestation, etc.),
  • social (human rights, child labour, employee relations, etc.), and
  • governance (corruption, executive pay, tax strategy, etc.)


Two main courses of action are favoured: taking ESG factors into account when building a portfolio, and actively encouraging companies already in the portfolio to improve their ESG performance.

 

Balancing values and returns?

Various indices measure the performance of responsible investment funds. For example, in a report from 2018, Morningstar found that these funds held their own in terms of returns, volatility and financial health.

More recent data echoes this finding, as shown in the following graph comparing the MSCI KLD Social Index with the larger MSCI USA IMI. Over the past 10 years, the performance of the socially responsible segment has been comparable to that of the larger index. (As always, it should be noted here that this is historic data and that past performance is no guarantee of future results.)

 

Line graph comparing the performance of the MSCI KLD 500 Social Index to that of the broader MSCI USA IMI from 2010 to 2020. We can see that the curves and behaviours are almost identical.

 

Responsible investing for a personal portfolio

For the individual, one way to exercise some leverage in the area of ESG might be to invest in funds or fund portfolios that are themselves “ESG aligned.” A possible starting point might be specifying the issues where you would like to have an impact and, with the help of your mutual fund representative, building a portfolio of appropriate funds.


Early this year, Sustainalytics published a report identifying 10 ESG-inspired investment “themes” for 2020. These range from biodiversity to “slow fashion” to digitalization of the mining industry. At a more global level, the United Nations has identified 17 sustainable development objectives, including such targets as zero poverty and hunger, gender equality, access to clean water, and affordable clean energy.

Some inspiring food for thought for the responsible investor.

The following sources were used to prepare this article: 

Actualis, What is responsible investment? 


 

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