What is Sustainable Investing?

Written by MASECO Private Wealth

The rise of investing for sustainability

We face real and difficult challenges due to climate change. Earth is our only home. Unfortunately, the unchecked carbon emissions over the last century are now affecting our daily lives and threatening our future. Many people are changing their habits and lifestyle choices to reflect their concern.  Sales of electric vehicles, solar panels, and organic food are rising. So too are sales of sustainable investments.

Sustainable investing has grown significantly with global investments now at $35.3 trillion. This amounts to 36 percent of all professionally managed assets according to the Global Sustainable Investment Alliance[1]. The financial services industry has responded to this demand with a dizzying array of product launches. Seventy-one new sustainable mutual funds and exchange traded funds were launched in the US in 2020 alone[2].

This is good news for sustainably minded investors, who now have more options. The bad news is that fund managers are not using consistent terms to describe their products. Managers use the terms ESG and SRI interchangeably – or call the whole field impact investing. Others use terms such as values-based investing, ethical investing, or even just responsible investing. The lack of a common nomenclature makes it difficult for investors to understand what investment choices are available, and what the performance might be.

Defining sustainable investing

We choose to use the term ‘sustainable investing’ as a catchall phrase for all forms of responsible investing. In 1987 the UN defined sustainability as “meeting the needs of the present without compromising the ability of future generations to meet their own needs”. That covers a lot of ground so there are probably a thousand different ways to invest with that goal in mind, but most ways can be grouped into three distinct categories:

• ESG or Environmental, Social and Governance Investing
• SRI or Socially Responsible Investing
• Impact Investing

As illustrated in Chart 1, these three forms of sustainable investing span the spectrum of opportunity between conventional investing, where financial returns are the priority, to philanthropy, where positive social or environmental outcomes are the goal.

The “Value Driven” categories on the left include both “Conventional” and “ESG” strategies that are designed to maximize financial return for the risk taken. They emphasize financial return first. The “Values Driven” categories on the right include SRI and Impact investing that consider financial return after the investors’ values have been satisfied.

Fund managers often blur the lines between these categories so they can seemingly promise the trifecta of the good financial performance from ESG, the values alignment from SRI and the positive outcomes of Impact simultaneously but these categories are quite different in approach, and in results, so we detail them a bit more, from the oldest form, SRI, to the newest, ESG.

SRI Investing

Socially Responsible Investing has been around for hundreds if not thousands of years. The socially responsible investor tends to avoid investing in certain companies because of the products the companies make, or the way they conduct business. Commonly ascribed to religious or deeply ethical investors, SRI strategies typically exclude problematic companies or even whole industries from portfolios.

A typical SRI fund may exclude some or all of the five ‘sin stocks’: companies that produce alcohol, tobacco, gambling, pornography or weapons. Some are built for specific religions or belief sets. Catholics can find funds that exclude abortion providers and stem cell researchers. Vegans have funds that exclude companies in the meat industry and those that do animal testing.

We believe that SRI strategies have historically struggled to achieve market rate returns because they tend to be less diversified, have higher costs, and exclude riskier stocks that often have high returns.

Impact Investing

Impact investing has common cause with philanthropy—the primary objective of both is to address a social or environmental problem usually in a specific location or for a particular group of people. The idea is to use a for profit approach, rather than non-profit, to deliver goods and services to areas of need.

Most impact investments are private placements, meaning the investor is placing their capital in a single project or an unlisted company. They require extensive due diligence as typically they aren’t registered for sale to the public, are often illiquid, and may have long lock up periods of 7 years or more. Given the high risk, impact investments usually make up a small percentage of investor portfolios.

ESG Investing

ESG investing is the explicit inclusion of the environmental, social, and governance risks and opportunities that companies face into traditional financial analysis and investment research. The term was first defined in 2005 in the landmark United Nations report, “Who Cares Wins.” While ESG investing is less than 20 years old, it has quickly become the most popular form, representing over 70% of all assets managed responsibly[3]. We’ll go into more detail on ESG investing, as it is the approach, we at MASECO take.

Traditional security selection employs fundamental financial ratios to identify companies to either invest in or avoid. ESG investing does that as well, but adds environmental, social, and governance factors into that analysis. ESG provides more information on companies than what is found in their standard financial reports.

Chart 2 lists typical ESG issues that could represent material risks or opportunities to companies.

The environmental factor “E” captures data on the natural resources that a firm consumes and how much it pollutes. All other things being equal, a firm that uses less natural resources or pollutes less, should have lower costs as they grow. Many countries adopted the international treaty on climate change which was agreed at the UN Climate Change Conference (COP21) held in Paris, France in 2015, commonly known as the ‘Paris Agreement’. The Paris Agreement included goals to reduce emissions dramatically over the next few decades. If these countries increase the amount they regulate, tax, or otherwise price carbon, companies that have higher carbon emissions will experience higher costs.

The social factor “S” represents people issues. Firms with higher worker satisfaction tend to retain employees for longer, reducing staff turnover costs. Companies with safer products or excellent client relationships face less lawsuits, recalls, and boycotts.

The governance factor “G” captures issues like board independence, executive pay, and employee ownership. Many studies indicate that poor corporate governance can adversely affect corporate financial performance.

Typical ESG funds will underweight or exclude companies with excessive exposure to certain ESG risks. Companies with outsized carbon emissions, poor safety records, or a history of regulatory violations could be shunned.  Some funds exclude thermal coal companies, or oil and gas majors that aren’t shifting to renewable energy. ESG funds also might overweight companies that are leading their specific industry in the transition to sustainability. Some ESG fund managers are committed to stewardship activities such as shareholder engagement, where they directly encourage companies to improve their performance on key sustainability issues.

Individual investors who are concerned about climate change and other systemic problems are quickly adopting ESG. ESG investments are attractive to investors who want to achieve their financial goals and encourage companies to adopt more sustainable practices.

MASECO’s Approach

Our approach to sustainable investing is focused on ESG. With an ESG approach, we can follow a similar investment philosophy and principles to which we adhere in our conventional strategies. We employ an evidence-based approach to ESG and select only the fund providers that we believe can deliver a sustainable investment experience whilst still seeking to achieve financial returns.

If you are interested in learning more about our sustainable investment solutions, we encourage you to speak to your wealth manager.  Sustainable investing won’t solve all our future challenges by itself, but moving our capital towards solutions and away from problems is a step in the right direction.

Sources:

[1] Global Sustainable Investment Review 2020, Global Sustainable Investment Alliance. https://www.gsi-alliance.org/wp-content/uploads/2021/08/GSIR-20201.pdf, 15 August 2023
[2] Report on US Sustainable and Impact Investing Trends 2020, US SIF. https://www.ussif.org/files/US%20SIF%20Trends%20Report%202020%20Executive%20Summary.pdf, 15 August 2023
[3] Global Sustainable Investment Review 2020, Global Sustainable Investment Alliance. https://www.gsi-alliance.org/wp-content/uploads/2021/08/GSIR-20201.pdf, 15 August 2023

This document is intended for clients or prospective clients of MASECO LLP.  It is for the use of the recipient only and may not be forwarded, copied or distributed, in whole or in part, without our prior written consent.

Use of information

• Nothing in this document constitutes investment, tax or any other type of advice and should not be construed as such.
• The investments and strategies noted in this document may not be suitable for all investors and making available the information in this document is not a representation by MASECO that any investment strategy is suitable for any particular client.
• This document is provided for information purposes only and is not intended to be relied upon as a forecast, research or investment advice.
• This document does not constitute a recommendation, offer or solicitation to buy or sell any products or to adopt a particular investment strategy.

Risk Warnings

• All investments involve risk and may lose value.  The value of your investment can go down depending upon market conditions and you may not get back the original amount invested.
• Your capital is always at risk.
• Although the information is based on data which MASECO considers reliable, MASECO gives no assurance or guarantee that the information is accurate, current or complete and it should not be relied upon as such.
• The environmental, social governance (ESG) considerations in sustainable investing may affect the ability of product providers to invest in certain companies or industries from time to time.
• Investment results of portfolios that do not apply similar ESG considerations to their investment process may differ.
• To achieve sustainable investing, a product provider may need to:

1. limit the types and number of investment opportunities available to the product and, as a result, the product may underperform other products that do not have an ESG focus; and
2. concentrate investment in specific sectors, countries, currencies or companies and exclude others resulting in a product that may be more sensitive to any localised economic, market, political, sustainability-related or regulatory events.

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MASECO LLP is authorised and regulated by the Financial Conduct Authority for the conduct of investment business in the UK and is registered with the US Securities and Exchange Commission as a Registered Investment Advisor.