Responsible Investment under the spotlight

Written by Peter Babudu, Senior Impact Advisor at Prime Advocates

Responsible investment is enjoying a major surge in popularity – and rightly so. But if it is to be more than a fad, investors will need to address some thorny issues.

What is responsible investment?

Responsible investment has many definitions. One of the most popular is that responsible investment involves integrating “environmental, social and corporate governance (ESG) considerations into investment management processes and ownership practices in the belief that these factors can have an impact on financial performance”. So, responsible investment involves looking at a broader set of factors around an investment and understanding the effects of an investment beyond its direct financial return to the investor. Critically, it is closely tied to the idea that looking beyond financial metrics does in any case aid long term financial performance.

Responsible investment encapsulates a range of different types of investment and investment strategies, from investing in renewables and divesting from fossil fuels, through to impact investment where market financial returns are blended with the intrinsic social or environmental benefits of the underlying investment. Responsible investment can involve passively screening out some investment opportunities that are widely viewed as a net bad for society (e.g. cluster munitions), or it can involve becoming more actively involved when you have a relevant concern regarding one of your investments – e.g. flagging bad governance practices in one of your investments.

Responsible investment can be broken down into a few broad camps. Firstly, basic ESG compliant investments, where investors determine certain investments or practices that will be excluded from their portfolio. Second, active ESG compliance where investors positively screen, seeking to direct more funds towards investments which contribute towards some positive social good. And finally, impact investment strategies, where the core purpose of the investment is to deliver a blend of positive social impact and financial return.

Why is responsible investment becoming more popular?

Responsible investment is enjoying a surge in popularity for three main reasons. Firstly, there has been several glaring examples of the potential downside of investing in companies that have significant ESG issues – for example, investors who did not pay attention to governance concerns at Volkswagen saw the value of their investment battered as the company faced widespread market opprobrium and billions in fines. This, tied with demographic trends has fed into a notable shift in investor sentiment towards responsible investment as more and more of the customers investors’ ultimately serve expect their money to be managed in ways that align with their personal values.

Secondly, there is growing evidence that ESG star performers often outperform the market. As recently reported in the Financial Times, companies seen as outperforming the market on ESG factors have been outperforming the market financially as well, according to MSCI Emerging Markets Leaders index. This combination of “being good and doing good” is understandably attractive to a wide range of investors.

Finally, it has become easier than ever to identify responsible investment opportunities and to invest in them in a scalable and affordable manner. From BlackRock to sustainability/responsible investment focused firms like Impax Asset Management, investors now have an embarrassment of opportunities to allocate funds in a responsible way. According to the Forum for Sustainable and responsible Investment, one in five of every $ under professional management in the US – c.$9 trillion – is invested according to socially responsible principles.

Is responsible investment a bubble?

But there are alternative perspectives on the responsible investment boom and they raise valid concerns regarding the extent, and the drivers of the rapid growth in responsible investment.

Firstly, non-responsible investments may be in much better health than choice figures suggest. Whilst various stocks drop rapidly on ESG concerns, they have a habit of picking up quite rapidly not long afterwards. Recent examples of this trend include Wells Fargo, Barclays and United Airlines, all of which have had major scandals in recent years but have had relatively speedy recoveries in their share price and underlying performance.

Secondly, much of the outperformance relative to the market of responsible investments has happened in the context of the post-financial crisis landscape, which even the most optimistic of responsible investors is likely to accept has been anything but a “normal” time in most markets.

Finally, and perhaps most critically, there is widespread concern that responsible investment is a broad church with little by the way of accepted criteria, making headline figures about how much responsible investment occurs less than trustworthy. Whilst we are yet to see a major ESG/responsible investment scandal, there are no generally accepted accounting practices for responsible investment so our assessment of the size (and by implication, the performance) of the responsible investment market relies on proprietary, and often quite partial, methodologies for assessing what constitutes responsible investment.

How will responsible investment thrive in the long term?

As responsible investment takes hold it’s only right that it undergoes greater scrutiny. If responsible investment is to survive that scrutiny, a few things will be critical. There needs to be more done to look at the performance of responsible investment in the medium term, as assessing responsible on its performance during a periodic of broad financial (if not economic) resurgence, is far from a robust approach. Secondly, there must be greater agreement, and more rigorous criteria on what constitutes responsible investment. This will increase the market’s confidence on how responsible investments actually perform. Finally, organisations making responsible investments need to ensure that they are properly developing and documenting their responsible investment strategies. Having a clear policy, which sets out what you mean by responsible investment, how it applies across your portfolio, a process for monitoring the long-term performance of these investments (in responsibility as well as financial terms) and a clear allocation of responsibility to officers who are senior in organisations will be critical as well.

At Prime Advocates we are working with various investors to help them determine what responsible investment means for them, and how it applies across their portfolios. For some investors, either because of the diversification needs they have or the scale of assets that they need to deploy, liquidity requirements or similar factors, they are not currently in a position to rigorously apply responsible investment practices across their entire portfolios. But even here, there is often space to be more ambitious with parts of firm’s portfolios, whether that is through creating a dedicated impact fund or having readily applied passive screens in limited scenarios.

What can we conclude about responsible investment?

It’s abundantly clear that responsible investment is here to stay. But with good reason, it is far from the only game in town at present. If it is to become the only game in town, responsible investment approaches will have to become far more transparent and be subject to more longitudinal analysis to fairly assess what impact responsible investments have as well as the effect these approaches have on the risk/return profile of any specific category of investment. Once these things are clear, investors will be able to credibly say that investing in any other way is simply irresponsible.

Peter Babudu is Senior Impact Advisor at Prime Advocates. if you would like to discuss any issues raised above further contact peter@primeadvocates.com


About Prime Advocates

Prime Advocates is a not-for-profit law-firm and strategic business consultancy. We use our market-leading expertise to pave the way for positive social change by providing the legal, strategic and financial advisory support which helps organisations break down the barriers to social finance. Driven by our genuine passion for the sector and a strong global network, we work with a range of clients worldwide, from impact investors and family offices to social enterprises and corporations. We primarily seek to support clients who are working towards achieving any or all of the seventeen UN Sustainable Development Goals, including gender equality, quality education, and climate action, but our ex-City lawyers and business consultants have wide-ranging experience across all traditional sectors.  Our services include:

• Legal : We specialise in social finance, fund finance, equity finance and digital assets (blockchain), but also provide a range of general commercial and finance support to traditional firms.

• Business advisory: We help firms improve their investment readiness, develop strategies, business plans & to navigate key decisions.

• Impact : We can support firms whether they require assistance developing basic ESG policies or help establishing bespoke impact methodologies and procedures for a dedicated impact fund.