An increasing number of investors seek out investments that take into account value for people and planet, alongside a financial return. Changing societal sentiments, upcoming legislations, and increasing evidence that sustainable investments yield better financial returns, drive awareness about the importance of responsible and sustainable investing for investors of all shapes and sizes. However, the array of terms and acronyms used in the space – from SRI to ESG to triple bottom line and impact – contributes to investor confusion. This article sheds some light on concepts, strategies, trends and developments.
ESG investing means taking Environmental, Social and Governance factors into account in investment processes, from due diligence to exit. ESG focuses primarily on an entity’s operations business practices, such as whether the portfolio company has in place anti-corruption policies, CO2 reduction strategies, and good labour-practices in its supply chain.
ESG factors could include GHG emissions, water use, diversity & inclusion, safety & privacy, to name but a few. There is broad consensus that integrating ESG in investing processes ensures value creation – both for people and planet, as well as improved financial return. The latter has a link to risk, a second important driver of ESG: low ESG scores increasingly indicate risks that may result in large financial implications.
Managing ESG in investments hence includes identifying material ESG topics (e.g. those topics that are most relevant in the entity’s context), screening for material ESG risks, as well as actively engaging with portfolio companies to support the improvement of ESG performance. Currently, it is estimated that about 25% of all assets managed globally incorporate ESG factors, and this number is growing rapidly.
In the investor space ESG is increasingly considered ‘hygiene’, and focus is starting to shift to impact investing alongside ESG integration. Where ESG focuses on the operations, impact investing focuses on the products and services a company is producing. As such, “impact investments” are considered to be investments in companies producing products and services that are intended to create positive change (impact) for people and planet, and are contributing to solving the world’s societal challenges, such as tackling water scarcity and malnutrition, innovations that accelerate the energy transition, improving health and wellbeing, or contributing broadly the Sustainable Development Goals (SDGs).
Important in this regard is intentionality (what impact do the company and fund aim to achieve?), investing with the aim of financial as well as social and environmental returns, and measurable impact.
What’s your strategy?
Whether screening for ESG risks, aiming to improve ESG performance, or impact investing is the right strategy for your organisation or fund, depends on your objectives and stakeholders. Do you aim to become best in class in terms of sustainable and impact investment? Are you targeting specific LPs and impact-focused funds? Can there be a trade-off between financial returns and impact, and if so – how much?
Be advised that a number of developments are underway that will accelerate the transition towards sustainable investing: In 2018 the European Commission launched an ‘Action plan for financing sustainable growth’, which has since led to the ‘EU Disclosure Regulation EU/2019/2088’: a regulation that requires all financial markets participants in the EU to disclose non-financial information about their investments from March 2021 onwards. Moreover, the Commission is working on an EU Taxonomy: a screening framework presenting a list of economic activities that make a substantial contribution to climate change mitigation and criteria to do no significant harm to other environmental objectives. It is expected the taxonomy will come into force in 2021, requiring investors to use it if they classify their portfolios as ‘sustainable’.