Institutional investors have a fiduciary responsibility to maximize return. Increasingly, they must also consider the social and environmental impacts of decisions made by the investment managers they hire. While some investors may view this as a dilemma that requires tradeoffs between investing for return and investing to advance specific environmental, social and governance (ESG) objectives, we believe a well-designed responsible investment strategy can help investors reconcile what otherwise may appear to be mutually exclusive goals.
Responsible investment strategies can be designed to meet a variety of investor objectives. They can give priority either to the pursuit of risk-adjusted return or social and environmental impacts, depending on the investors’ objective. Investing approaches that integrate consideration of ESG factors can give investors an enhanced understanding of a sometimes overlooked source of portfolio risk as well as the means to improve risk-adjusted returns by identifying and addressing environmental, social, and governance risks. Other responsible investment approaches such as screening, tilts and impact/thematic investing provide additional ways for investors to align their investments with their personal or institutional values.
Responsible investment strategies target a range of impact and financial return objectives. Many target the same competitive rate of return as their conventional counterparts. Others may require an investor to accept a lower rate of return in exchange for pursuing a specific environmental or social goal.
Responsible investing approaches can be designed to in accordance with either priority and they can be classified into four categories. The practice of identifying and incorporating ESG factors into investment decision-making is known as ESG integration and may benefit institutional investors by improving their risk-adjusted returns. Active ownership strategies take a step beyond integrating ESG analysis to use managers’ rights as shareholders to press companies to adopt best practices regarding the ESG issues that the analysts have identified. Finally, screening or tilting approaches let managers align investors’ portfolios with their values by either avoiding or emphasizing certain industries and sectors, while thematic or impact investing puts client assets to work by investing in assets, companies or projects that are meant to have positive and measurable environmental or social impacts as well as generate return. Both of these approaches may target competitive rates of return or require trade-offs in terms of investment performance.
Regardless of the approach a manager takes to responsible investing, the momentum driving the mainstreaming of approaches that consider environmental, social and governance factors in investment decision-making appears unlikely to reverse. Fortunately for investors, investment managers are continuing to respond to that interest with ever-more sophisticated methods of understanding and addressing the relationship between investors’ objectives and the world in which they live.
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As the terms to describe ESG-aware investing continue to evolve, it should be noted that "socially responsible", "sustainable" and "ethical investing" have been used to describe ESG investing activities in other mentions on our website.
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