Blending returns and responsibility
Once considered an investment industry niche, socially responsible investing (SRI) is gathering momentum as a core investment strategy for institutional and retail investors alike.
SRI combines profit-driven traditional investing and purely social motivations. It takes a variety of forms, catering to a wide range of investor needs.
An active approach is especially beneficial when building SRI portfolios, particularly because shareholder engagement is a critical component of a comprehensive approach to SRI.
1. Into the mainstream
SRI is the integration of environmental, social and governance (ESG) considerations into the selection and management of investments. Portfolio managers who apply an ESG screen ask questions such as:
- Is the company developing products that advance sustainability?
- Is the company contributing to the degradation of the environment?
- Is the company committed to increasing gender and ethnic diversity?
- Is there a majority of independent directors?
Once considered a niche in the world of investing, SRI has in recent years powered into the mainstream. Globally, SRI assets currently stand at US$23 trillion.1 In Canada, SRI accounts for 38% of invested assets.2 And while institutional investors are the primary source of these assets, retail investors are showing increased interest in SRI. Retail SRI assets in Canada have reached $118 billion, reflecting a two-year growth rate of 91%.3
A recent survey by the Responsible Investment Association (RIA) showed that 82% of investors would like to dedicate a portion of their portfolio to SRI, while 77% said that companies with good ESG practices are better long-term investments.4 The majority of those surveyed (58%) said they would divest from a company due to ESG concerns.5 Other RIA research shows that millennials and women are likely to drive continued growth in SRI over the coming years.6
But SRI has been largely overlooked by financial advisors. A Morgan Stanley survey found that 60% of U.S. advisors reported little or no interest (Figure 1).
Figure 1: Investor and advisor interest in SRI
Source: Morningstar Magazine, December/January 2016. Data via Morgan Stanley Institute for Sustainable Investing and Cerulli Associates.
If this data is reflective of Canadian advisor attitudes, it is particularly striking given that a strong majority of Canadian investors say they would be more likely to choose responsible investments if their financial advisor suggested suitable options.7
2. Blending values and financial goals
Investing has traditionally revolved around a purely financial question: How much risk are you willing to take to achieve a given level of return? Questions about social or environmental impact rarely, if ever, came into the picture.
For those who wished to use their wealth to have a positive impact on the world, philanthropy was the only avenue. Apart from its possible tax advantages, philanthropy is purely charitable.
With the emergence of SRI, investors can now explore a new middle ground that aims to be both socially responsible and profitable. Indeed, many SRI solutions available today offer potential to match or exceed the performance of traditional mutual funds with comparable asset mixes.
SRI’s alignment of financial and non-financial goals, which many are referring to as the new paradigm, involves opportunities that span four key dimensions:8
- Competitive returns: For investors looking to achieve benchmark or market-beating returns
- ESG risk management (negative screening) : For investors who see ESG analysis as another level of risk management, or those who wish to avoid investments in companies whose primary line of business includes tobacco, nuclear power, military weapons, adult entertainment or gambling
- ESG opportunities (positive screening) : For investors seeking companies that actively pursue a progressive ESG agenda
- High-impact opportunities : Focuses on areas such as clean energy, water scarcity, or redevelopment of low-income areas
It is important to emphasize that not all SRI opportunities incorporate each of these four dimensions. By the same token, different investors will prioritize these dimensions differently, or may be interested in some, rather than all of them. Advisors can play a critical role in helping clarify investor preferences and identifying investment solutions that match them. Figure 2 can help facilitate this process. (Note that the term SRI serves both as an umbrella term for the new paradigm and as a subset of the opportunities within that paradigm.)
The table shows, for example, that an investor intent on incorporating all four dimensions can look to opportunities within SRI and thematic impact investing. By contrast, an investor who prioritizes competitive returns and ESG risk management may be well served by considering RI, SRI and thematic opportunities.
Figure 2: The new paradigm
Source: Adapted from Bridges Ventures, “The Bridges Spectrum of Capital: How we define the sustainable and impact investment market,” 2015.
3. An active approach
For retail investors, a key entry point into SRI is the traditional mutual fund. Investing across the wide spectrum of SRI equity and fixed-income mutual fund solutions can help investors build portfolios that meet both their investment and social goals. But not all SRI funds are created equal. For example, some funds billed as SRI use ESG analysis more as a preliminary screening tool than an integral part of the security selection process. Others may lack the active commitment to shareholder engagement that many investors are looking for.
Key features of funds that offer a comprehensive, four-dimension approach to SRI include:
- ESG analysis that incorporates both negative and positive screening
- A requirement that all potential holdings satisfy the selection criteria of both ESG specialists and financial analysts
- A commitment to continuously monitor all fund holdings to ensure companies maintain the ESG standards that qualified them for inclusion in the fund
- Vigorous engagement with companies that deviate from their ESG commitments
- A statement in the prospectus that identifies SRI as a core driver of security selection
Actively managed socially responsible investments such as the IA Clarington Inhance SRI funds and portfolios incorporate each of these criteria and can help investors meet their financial and social goals.
- Active management – An investment approach that uses research and analysis to select stocks or other securities with the goal of outperforming a designated index or benchmark.
- Institutional investor – Large investors, such as pension funds, banks, mutual funds, foundations and endowments.
- Long-only fund – An investment fund that only buys positions in securities, i.e., does not engage in short selling of securities.
- Private equity – An investment in privately held assets, as opposed to publicly traded securities.
- Shareholder engagement – Refers to the practice of some SRI portfolio managers of challenging companies to adhere to high ESG standards.
(1) Global Sustainable Investment Alliance, “2016 Global Sustainable Investment Review.”
(2) Global Sustainable Investment Alliance, “2016 Global Sustainable Investment Review.”
(3) Responsible Investment Association, “2016 Canadian Responsible Investment Trends Report.”
(4) Responsible Investment Association, “2017 RIA Investor Opinion Survey.”
(5) Responsible Investment Association, “2017 RIA Investor Opinion Survey.”
(6) Responsible Investment Association, “Millennials, Women, and the Future of Responsible Investing.”
(7) Responsible Investment Association, “2017 RIA Investor Opinion Survey.”
(8) Bridges Ventures, “The Bridges Spectrum of Capital: How we define the sustainable and impact investment market,” 2015.
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