Over the past few decades, sustainable investing has seen tremendous growth, and both individual and institutional investors the world over are flocking to this investment concept in record numbers. Total SRI assets in the U.S. reached $8.72 trillion in 2016, according to U.S. SIF—a 14-fold increase since 1995. McKinsey reports that over a quarter of professionally managed investments globally are subject to some form of SRI or ESG criteria.
To understand what is driving the market today, it helps to understand how it has evolved over the course of its long history. The earliest forms of sustainable investing were rooted in ethical and faith-based stances by investors who wanted to eliminate investments from their portfolio they considered unjust, amoral or sinful. Ethical investing practices are referenced in both the Old Testament and the Qu’ran. Since at least the 1700s, Quakers, Methodists and other religious organizations have applied what we now call “negative screens” to their investments, forbidding investments in a wide range of activities such as the slave trade, alcohol, tobacco, gambling, war and many others.
Starting in the 1960s and 1970s, the concept of shareholder activism became a core tenet of sustainable investing, as investors sought to directly drive societal change through the redirection of investment capital. Perhaps the most famous example of activism is the apartheid divestment campaign, in which stakeholders pushed universities and other institutions to cease investing in companies doing business in South Africa. This effort gained critical mass in the 1980s, and is viewed as a major contributor to the end of apartheid.
Shareholder activism over time has evolved. Today, a host of investors and asset owners engage companies in collaborative dialogue, or file proposals for consideration by a company’s shareholder base, to urge companies to make progress on a variety of issues from gender equity to climate risk.
The third core concept in sustainable investing is the idea that consideration of environmental, social and governance (ESG) factors in investment research can identify risks and opportunities and can help to enhance investment decisions. Over the last several decades, academics and investment firms have debated the performance merits of ESG investing, but in recent years, more and more mainstream investment firms and fiduciaries have begun to incorporate these factors into their investment processes, viewing them as important and legitimate risk factors that affect a company’s long-term prospects.
A more recent evolution of sustainable investing is the concept of impact investing, in which investors seek a measurable “societal return” on their capital. An impact investment is measured not just on the financial returns it generates, but by the measurable progress it drives. The questions asked by impact investors—does Company X’s activities reduce prison sentences? Does the company offset carbon emissions? How can we measure the direct influence of Company X on these metrics?—are often very difficult to answer, and investment firms are developing entirely new datasets and frameworks in order to more effectively measure and report impact to their clients.
This arena of investing has evolved rapidly over the past few decades, and the landscape can be confusing. Terms like “socially responsible,” “ESG,” “sustainable,” “mission-aligned” and “impact” are often used interchangeably by investment firms and by the media, and it is not always apparent to those new to the space how everything fits together. And with the wide array of options available today—with many different strategies marketing themselves using very similar terms—investors can easily feel overwhelmed by the prospect of choosing which strategies will be most effective for them.
Every client is different, and every sustainability-minded client has different considerations that he/she prioritizes, but in the end, all are pursuing some combination of three things: 1) attractive performance, 2) a portfolio aligned with their values, and 3) they want their investments to make a positive impact on the world. If we can determine how a client views and prioritizes these broad goals, we can begin to help him/her build a strategy that fits his/her objectives. Similarly, if you can effectively answer these questions for yourself through a process of discovery—either on your own or with trusted advisors—you can begin to seek out managers whose sustainable investment approach mirrors your own goals and values.
In this process, it is essential to do solid research on managers to ensure that you understand their underlying philosophies and processes. Many managers claim a sustainable investing mantle but only apply the lightest of negative screens and do no actual integrated ESG research. A large majority of the global SRI assets sit in such portfolios; for example, the largest SRI fund in the U.S. has over $100 billion in assets, but its sustainable investing effort is limited to screening out alcohol and tobacco investments. If your goals are entirely based on avoiding alcohol and tobacco investments, this may be a great option for you, but if you are seeking to adopt a wider range of sustainable considerations, you will need to dive deeper.
Sustainable investing
A growing number of individual and family relationships are guided by sustainable investment goals and policies, and a substantial portion of institutional clients look for assistance with sustainable investing objectives. Support for these clients must help them balance their performance, values, and impact goals as described above.
Institutional investors focused on sustainable investing often have a fully integrated ESG research process, including embedded ESG research analysts on equity and fixed income research teams, and a proprietary ESG risk analysis that every security is subjected to. .
Conventional wisdom has long held that performance and impact goals are at odds with each other, but these goals are quite complementary. When credit and ESG research are conducted within a single, unified due diligence process, impact and ESG considerations are a core part of the investment thesis for every security in the portfolio. This ensures that each investment clears a high fundamental credit bar as well as a high impact bar prior to investment.
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