Want to be a responsible investor? Step one: cut through the jargon
It’s impossible to ignore the incredible boom in the popularity of sustainable investing.
Stats from the Global Sustainable Investment Alliance (GSIA) show the amount of assets managed as “responsible” hit $22.9 trillion in 2016. That was a rise of 68% on 2012.
One of the key drivers behind the growth has been rising interest from millennials.
Schroders' 2018 Global Investor Survey found that millennials are more likely to value and invest in sustainable investment funds: millenials are allocating an average of 41% of their portfolios to sustainable investments, compared to 34% of Baby Boomers.
The catch-all phrase of “sustainable investing” is used to sum up a whole range of issues and ways of investing.
I work in sustainable investment so I’m perhaps well placed to explain some of the dizzying array of terms and definitions that the industry has hatched over the years. We’ll aim to distinguish between terms commonly grouped under the broad “sustainability and ESG” umbrella (ESG stands for “environment, social and governance”, by the way).
If you’re interested in joining the growing ranks of sustainable investors, it’s good to get a handle on the jargon.
At a high level, this involves examining a company’s environmental, social and governance performance. This could be you as a direct shareholder, or it could be your investment manager doing it on your behalf.
The environmental bit is as you’d expect: shareholders put pressure on companies to properly consider and potentially reduce their impact on climate change, for example.
On social it’s about companies being good corporate citizens, or assessing their ability to adapt to social pressures and trends such as demographic changes, social attitudes, social trust and other beliefs or behaviours.
Governance refers to the quality of a company’s structure and practices, ensuring management balances the interests of its many stakeholders, such as shareholders, customers and employers. Does it have the right checks and balances to make sure good decisions are made? Is the company accountable and transparent? The G, therefore, inevitably affects the E and the S.
Ethical investing is when you consciously rule out investing in a company because it is engaged in controversial activities. What’s classified as controversial is determined by an investor’s principles or beliefs.
For example, an investor may exclude companies directly associated with pork or alcohol for religious reasons. Or they avoid ‘sin stocks’ which get their profits from activities such as tobacco, alcohol, gambling or adult entertainment.
This approach is sometimes called “values-based”. A few other terms are worth mentioning: socially-responsible investing or SRI is perhaps the oldest and most established term relating to sustainable investing. Definitions of SRI vary but it largely relates to the sort of screening out of stocks, mentioned above.
When integrated with more traditional ways of measuring a company’s prospects, sustainability analysis can potentially improve insights and enhance performance. We define sustainability as the features that ensure companies, industries or markets can operate within their means and maintain stability over the long term.
The aim is to provide a more complete understanding of future opportunities and risks compared to traditional analysis. Sustainable investing can also mean the exclusion of certain activities or industries, but rather than being driven by ethical motivations, this will be because these industries might face deep-seated problems that make them poor long-term investments.
Impact investing means investing with the primary goal of achieving specific, positive social benefits while also delivering a financial return. This typically takes place in private markets (i.e. not the stock market) and recipients tend to be small companies with clear social goals, who otherwise may not have access to capital.
Stewardship means creating a a purposeful dialogue between shareholders and boards. The aim here is to ensure that a company’s long-term strategy and day-to-day management is effective and aligned with shareholders’ interests. Again, this overlaps with some of the terms above.
That’s just a few of the basic terms.
We should also mention that the application of sustainable approaches varies depending on where you are in the world.
The Global Sustainable Investment Alliance says “negative screening” (i.e. automatically ruling out certain industries and companies) is the most common ESG approach in Europe, whereas corporate engagement and shareholder action dominates in Japan, for example.
Sustainability and ESG investing is often applied as a broad-brush term. A more detailed understanding can help you take that next step toward becoming a responsible investor. As an increasing number of investors of different age groups value ESG considerations in their investments, understanding these differences and their implications will be key.
Looking for more? Here are 50 terms every sustainable investor should understand.
View the original article on MoneyLens. MoneyLens is a website aimed at helping millennials manage their money.