The growth of responsible investing
10th January, 2020
Environmental, Social and Governance (ESG) investing, has become omnipresent in the last number of years. In its most general definition, ESG investing can be defined as the integration of Environmental, Social and Governance issues in investment decision making. At Davy Global Fund Management ("Davy GFM") we favour an integrated application of ESG factors in our investment process but we understand that there are lots of different investment strategy terminologies which are often grouped together under the responsible investing banner.
We consider ESG integration as distinct from values-based (ethical) investing, which seeks to only invest in areas aligned to the values of a particular body or group. This is typically expressed in portfolio construction in terms of exclusion of areas such as tobacco, alcohol and gambling. Another investment term in this area is thematic or impact investing, where investment in specific areas such as clean technology or social housing are targeted with a direct social or environmental benefit as the outcome. In this insight we acknowledge the increased application of impact or thematic investment strategies within the asset management industry, however we advocate a integrated ESG strategy.
Based on data compiled by the Global Sustainable Investment Review between 2014 and 2018, we can see, in Figure 1, that ESG integration makes up 53% of the responsible investment market closely followed by values-based investing. Impact or thematic investing represents a clear minority in share of AUM. However as shown in Figure 2 the four year growth CAGR (Compound Annual Growth Rate) figure is 57.3% between 2014 and 2018, considerable larger than ESG integration and Values-based, even when combined.
Figure 1:Share of responsible investment market 2018
Source: Global Sustainable Investment Review, as at 31st December 2018
Figure 2: Growth in responsible investing 2014 - 2018
Source : Global Sustainable Investment Review, as at 31st December 2018
While responsible investment has always been relevant for the cohort of investors which represents charitable organisations or public bodies, we see ESG integration becoming more mainstream in recent years. Signatories to the United Nations Principles for Responsible Investment (UN PRI), a body which promotes the integration of ESG into investment decision making among asset owners and asset managers, responsible for managing USD86.3trn of assets, has grown from 63 signatories to 2372 signatories in the last 13 years.
Figure 3: Growth of UN PRI Signatories and AUM
Source: United Nations Principles for Responsible Investment as at 31st March 2019
Regulation and increasing public demand for ESG-related investments remain key drivers for asset-owners, but investor motivation can be less clear cut. While the societal benefits are clear, the investment benefits can be less obvious. The motivation behind the application of responsible investing, from a fund managers perspective can range from customer demand to more specific investment characteristics, such as using ESG criteria as another risk metric. Research by Serafeim and Amel-Zadeh (2017) investigated the motivations for ESG investing among 652 mostly mainstream (non-ESG) portfolio managers, finding that investment performance was the main motivation for the use of ESG information when making investment decisions.
However, when approaching ESG information, either from an empirical or practical use, there are many aspects to consider, a selection of the most prominent issues are explained further below. There are certain considerations to take into account when analysing ESG data. Davy GFM has developed a deep understanding of these issues which we believe enables us to integrate ESG data into our investment decisions.
|Consistency||Aside from the typical issues which plague longitudinal studies, such as survivorship bias or data mining, ESG studies have additional data issues with which to contend as they evolve. In its infancy, ESG consideration was used as a measure of a company’s corporate social responsibility (CSR) activity, and at best a measure of the level of corporate disclosure in a given firm. As ESG criteria has hit the mainstream, investor, expectations for ESG research have increased and ESG performance has increasingly become a reflection of a company’s skill in managing the financially material business risks relevant to its given industry. This evolution has had a consequent impact on methodology, meaning that the criteria that made a “good ESG” company 10 years ago may not make a good ESG company today.|
|Quantifiability||ESG data is by its very nature non-financial and many ESG-based assessments are heavily subjective. This can make ESG data difficult or inappropriate to quantify. This inability to quantify some ESG data can make it difficult to interpret, hindering its adoption in investment decision-making.|
|Reliability||ESG data and research is heavily reliant on self-reported data. While efforts are being made to standardise definitions and data across industries, this remains an issue. On a firm level this affects comparability. For example, two companies within the industry may disclose different data or use different methodologies to produce the same data.|
|Classification||Historically, studies of ESG-compliant mutual funds have been used to demonstrate ESG’s ability to add value. As we mentioned earlier in this insight, ESG integration is distinct from Values-based and impact or thematic investing. Failure to appropriately classify ESG integrated strategies can mean strategies with very different goals or risk exposures being grouped together. This is particularly problematic when examining return or risk among mutual funds, significantly affecting the comparability of ESG data.|
At Davy GFM, we are heavily involved with the development of the integrated ESG investment market, both at a macro and micro level. Our involvement has ranged from the development of national sustainability training networks through to driving improvement in ESG data disclosure among corporates.
- UN Principles on Responsible Investing: We have been signatories since 2016. In the UN PRI’s 2019 reporting, we received an A+ grade under the main heading of Strategy and Governance, placing us in the top 22% of signatories globally.1
- Irish Sustainable Investment Forum (Irish SIF): SIF Ireland was established by the Irish investment community as a national platform to advance responsible investment practices across all asset classes. We have been a member of SIF Ireland since its formation in 2017 and have partnered with SIF on talks and publications.
- Sustainability Skillnet: One of our Fund Managers sits on the steering committee of Sustainability Skillnet, the body responsible for the development of a national sustainable finance training network as Ireland builds towards its 2025 Sustainability goals.
- US Sustainable Investment Forum (US SIF): We became members in 2019. This allows us to partner with US-based asset managers and asset owners on issues of market development and collaborative engagement with corporates.
- CDP Ireland (Carbon Disclosure Project): The Carbon Disclosure Project (CDP)2 is a global organisation aimed at improving corporate disclosure of environmental impact. The CDP has over 6,000 corporate signatories and originated from the United Nations Environment Programme. One of our Fund Managers sits on the steering committee of the Irish Chapter of the CDP.
At Davy GFM, we believe that Quality3 as an investment style is strongly complemented by ESG research, potentially offering a justification for sustainably better fundamental characteristics. We follow an investment philosophy based on our own definition of Quality. Based on the firm’s definition of QUALITY , a proprietary model has been developed founded on the four pillars of Profitability, Persistence, Protection and People, whose effectiveness is supported by in-house back testing.
We view responsible investing as a key part of our fiduciary duty to our clients. Fundamentally, we view a company’s ability to manage its ESG risks as representative of how it manages its long-term business risks and complementary to our QUALITY philosophy.
We maintain the reputation established by the Group since its inception in 1926, as a recognised leader in investment management. Our objective is to understand the circumstances and aspirations of each of our clients with the aim of sharing the commitment towards achieving their unique goals.
Brian Kennedy is a Fund Manager for the Davy ESG Equity Fund and also sits on the steering committee for the Irish Chapter of the Carbon Disclosure Project. Brian joined Davy in June 2015.
3QUALITY refers to DGFM’s in house definition which is explained in Davy Asset Management - “Quality Matters” White Paper – Chantal Brennan, Paraic Ryan, Hannah Cooney: 2016 (available on request). Note that this philosophy relates to that as developed within Davy Asset Management prior to its merger on 29th November 2019 with another entity of the Davy Group, Davy Investment Funds Services Ltd. It now reflects the QUALITY philosophy within the merged entity, Davy Global Fund Management.
Warning: Please note the factors listed are neither comprehensive nor exhaustive. There may be other factors that influence the investment process. This information does not constitute investment advice or a recommendation. It has been provided for discussion purposes only
The information discussed in this article does not purport to be comprehensive or all inclusive. It does not constitute an offer for the purchase or sale of any financial instrument, trading strategy, product or service. No one receiving this document should treat any of its contents as constituting advice or a personal recommendation. It does not take into account the investment objectives or financial situation of any particular person.
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Davy Global Fund Management Limited, trading as Davy Global Fund Management, is regulated by the Central Bank of Ireland. In the UK, Davy Global Fund Management is authorised by the Central Bank of Ireland and is subject to limited regulation by the Financial Conduct Authority (“FCA”). In Luxembourg, Davy Global Fund Management is authorised by the Central Bank of Ireland and is subject to limited regulation by the Commission de Surveillance du Secteur Financier (“CSSF”). Details about the extent of our authorisation and regulation by the FCA and CSSF are available from us upon request.