This article is taken from the latest Good Investment Review, from Good With Money and Square Mile Research.
The world is undergoing a dramatic transformation that will require responsible allocation of capital to address pressing environmental and social challenges and deliver shared prosperity. As such, some important responsible investment (RI) considerations include:
1. Definitions and a lack of standardisation
In a world where one investor’s ‘responsible investment’ can be another’s ‘sustainable investment’, widespread confusion reigns over the meaning of many RI terms. The fact that there are relatively few standardised definitions in terminology can lead not just to confusion, but a lack of clarity in investment processes. It could, in some cases, also inadvertently open the door to potential ‘greenwashing’ – where companies convey a false impression or provide misleading information about the strength of their environmental credentials.
Considering this, Church says: “Because there are so many definitions, what one investor understands as sustainable another may term as ESG1 integration
– and this is just one example of how definitions can blur. There is a need to make sure every RI-related term is clearly defined so investors can really know whatthey are getting with their RI strategies.”
2. Quality of data
Conflicting data sources can cloud the picture on Responsible Investment and this remains a major challenge.
The growth of the RI market has led to a proliferation of ESG-related data and ratings’ providers but since most company reporting on key ESG factors is currently voluntary, many investors are getting a fragmented and inconsistent view.2 Myriad methodologies and data aggregation can also create conflicting scores and outcomes – in some cases, making meaningful performance comparison extremely difficult.
According to Church: “Quality of data and availability of data are extremely important considerations. Discrepancy between third party data providers and the increasing need for forward looking data – which by its nature tends to be subjective – remains problematic. There is an urgent need for global alignment between key stakeholders – including governments, regulators, asset managers and corporations – to develop mandatory commitments to improve reporting on key ESG issues.”
3. E, S or G?
Tackling global warming and efforts to reduce carbon emissions to align with a net zero world, as well as ‘nature-positive’ investing, remain critical aspects of the ‘E’ in ESG. However, social aspects such as workplace equality and boardroom gender diversity can improve corporate decision making and, in many cases, financial performance. Companies committed to strong environmental stewardship and which are socially progressive are increasingly being recognised as more attractive investments than those which pay mere lip service to responsible commitments, particularly given the recent COVID-19 pandemic and macro backdrop.
Church says: “The pandemic brought the social aspect to the fore and raised the importance of the need for equality and a ‘just transition’ for all. This trend can only grow in importance as investors become more aware of the intrinsic benefits and value social improvements can bring.”
4. Geography matters
Global investors committed to investing responsibly face the headache that not all markets are as advanced or aligned as others in addressing ESG and wider RI concerns. Common standards do not exist across all markets and there is a plethora of regulatory frameworks across geographies.
Church says: “Geographic divergence across markets can present some significant investment challenges as to what RI means in regions such as Europe versus the US or Asia can vary widely. What is deemed a social value or norm in one market may be regarded differently in another market and investors need to be very alert to this.
“You can’t simply impose one market’s standards on another. The ideal scenario would be to have a single international standard for sustainability, such as that currently being developed by the International Sustainability Standards Boards (ISSB)3 but we are currently a long way from this ideal.”
5. Transitioning companies: investment friend or foe?
As the carbon transition evolves, many companies that raise finance in the
global capital markets are setting out credible plans to transition away from environmentally and socially challenged business models within the next five years.
Yet, without standardised global regulation in this field, it can be tough for investors to consistently analyse progress. With a dearth of reliable benchmarks, some investors continue to avoid carbon intensive sectors and companies even though these players may be committed towards serious emission reductions.
According to Church: “Many investors instinctively feel a company which is in transition cannot be labelled as sustainable. To date many RI flows have crowded into companies which already have the highest environmental or social ratings, but this can create overcrowding risk and potentially direct flows away from sectors which most urgently need to transition.
In future, we expect to see greater focus on identifying companies that aren’t best-in-class today, but which are credibly transitioning to align with a lower carbon world or are putting in place policies to ensure a better impact on environment and society.”
Risk warning: The Good Investment Review provides general information only. It is not financial advice. If you invest in any of the products mentioned in the review, you do so at your own risk. This is not a recommendation to buy or sell any funds mentioned or engage in investment activity with any particular fund manager. Capital is at risk and past performance is not a guide to future performance.