According to Morningstar research, assets under management in open-ended funds and exchange-traded funds in the broad category of responsible investing have grown from less than $500 billion 10 years ago to more than $3.5 trillion (€3.03 trillion) today. But what exactly is responsible investing and is that growth likely to continue in a world where the tide of political sentiment seems to be running against many of the principles underpinning these investments?
“Responsible Investment explicitly integrates environmental, social and governance [ESG] issues into the investment process, in addition to traditional assessments of risk and return characteristics,” says Patrick McLaughlin, head of responsible investment multiasset solutions, Davy. “The responsible investment space has evolved considerably from the once traditional negative screening. Whilst negative screening is still part of the process, there is a wider array of approaches.”
These approaches include best-in-class or positive screening, ESG integration, thematic and stewardship.
According to McLaughlin, positive screening involves applying filters to a universe of securities, issuers, investments, sectors, or other financial instruments to rule them in, based on their positive performance on ESG factors relative to industry peers or specific environmental, social, or governance criteria.
READ MORE
ESG integration is the systematic and explicit inclusion of material ESG criteria into investment analysis and investment decisions. Thematic investing involves the identification and allocation of capital to themes or assets related to certain environmental or social outcomes, such as clean energy, energy efficiency, or sustainable agriculture. Stewardship is “the use of influence by institutional investors to maximise overall long-term value, including the value of common economic, social, and environmental assets, on which returns, and client and beneficiary interests depend.”
Fabiola Schneider, assistant professor in accountancy at the University College Dublin School of Business, points out that responsible investing is nothing new. “It goes back a very long time,” she says. “It was previously known as socially responsible investing, but the application of ethics and values to investments goes back thousands of years. The Quakers had exclusionary criteria, as have other faith-based investments.”
While there has been something of a pushback against some of the policies underpinning these investments, Schneider believes it won’t make that much of a difference in the long term. “There was a big ESG hype and now we are seeing a backlash,” she notes. “It has been politicised and become quite emotionally charged. But including environmental risks in investment decision-making still makes financial and business sense. You don’t want to put money into a factory on a flood plain.”
The sound financial grounding of responsible investing is also noted by Carolina Angarita-Cala, head of sustainability with Cantor Fitzgerald. “The growth in the past decade reflects both investor demand and a broader reassessment of long-term risk,” she says. “Physical climate risk is intensifying. Investors are increasingly expected to understand supply-chain vulnerabilities, governance resilience and long-term environmental constraints. In the case of institutional investors, incorporating these factors is now part of prudent risk management.”
PwC asset and wealth management partner Olwyn Alexander concurs. “Responsible investment is increasingly being driven by economic reality rather than ideology,” she says. “Many of the issues it seeks to address – climate change, energy security, infrastructure resilience and supply chain stability – are no longer peripheral concerns but material economic risks that affect long-term growth and asset values. As these risks have become more visible and measurable, investors have begun to integrate them more systematically into investment decision-making.”
Some investors are looking for more than financial returns, and, in some cases, responsible investing aligns with the mission and objectives of certain organisations. “These organisations aim to create a positive impact in their area of focus,” McLaughlin explains. “Having assets managed in a responsible investment solution is consistent with these entities’ aims and does not undermine their goals.”
It also suits investors with a long-term perspective. “The long-term nature of philanthropic assets requires a long-term investment approach,” he adds. “An approach that considers sustainability issues is consistent with a long-term view. In addition, an investor can improve the underlying risk characteristics of their portfolio by investing in the companies that are best identifying and managing their material risks. In turn, this can lead to better risk-adjusted returns.”
Schneider points to large pension funds as examples of investors with a very long-term horizon. “We call them universal owners because they own such a significant portion of the entire global economy,” she says. “For them it makes sense to have a world with an orderly transition to net zero. They might accept lower returns in one field to have a healthy planet and economy in the long term. They don’t care about overnight returns.”
Reputation is another driver. “A responsible investing solution can minimise the likelihood of your investments undermining your message,” McLaughlin notes. “In our experience, responsible investors are well informed and motivated to minimise the adverse impacts of their investments. They are all doing this in the context of trying to achieve a financial return objective, which relies on ‘decent returns’. Applying a responsible investment approach can provide for a more rounded investment process and positively impact the risk-return characteristics of the investor’s portfolio.”
Responsible investing is continuing to mature, according to Angarita-Cala. “It has achieved strong growth over the last decade, which points to structural investor commitment. Its structures, outcomes, and governance frameworks will continue to evolve as investors increasingly use it as a framework for identifying, pricing and managing financial risks and opportunities.”
