Being a responsible investor
16th November, 2023
Everyone’s investment journey is a personal one. Questions to consider include how much to save, for how long, what types of investment to make depending on risk tolerance, and many more without evening starting to consider how to incorporate sustainability. However, this is a question coming more to the fore in recent years. As consumers, we are considering responsible sourcing in supply chains, labour practices, and environmental impacts in the products we consume daily - so why not reflect our desires to be responsible consumers with our investment products? But - where do you start?
What is responsible investing?
At Davy, we use the term Socially Responsible Investing when referring to investment activity that puts the method of investment on par with the financial outcome measured in risk adjusted return i.e., the how we invest is as important as the why. We believe this is an appropriate term as it encompasses the key areas of an investment approach, namely:
- exclusion on harmful activities and products
- integration of environmental, social and governance (ESG) factors into investment analysis
- engagement to affect change
- measuring impact
A base level of exclusions is deemed necessary to avoid harm (e.g. tobacco, human rights violators).However, the responsible investing movement has moved on in recent years from focusing on exclusions only, to assessing the risk and opportunities ESG factors represent to an organisation and trying to encourage better practises in companies that are lagging.
ESG is one of many acronyms used in the responsible investing world and this term can lead to confusion at best and be a deterrent at worst. Put simply, Environmental, Social and Governance factors are important considerations when looking at the operations of an individual company or country. This could be assessing the carbon footprint of a company, its labour practices or how company management incentives are aligned, or note, with responsible practises. ESG factors may be considered in a traditional investing approach also, but their importance is given a higher level of consideration with a responsible investing approach.
One of the most interesting developments in recent years is what is happening on the engagement side. We have seen a rise in collaborative engagement groups and initiatives to promote best practice. This is where a group of investors come together to encourage companies and countries to align their strategic plans with a greener, safer, and more equitable planet. By encouraging as many companies and countries as is realistically possible to improve practices, responsible investing will really meet its non-financial aspirations.
What are my options?
The Wealth Allocation Framework at Davy provides the basis for meeting your financials aspirations. The framework breaks down an investment portfolio into:
- A liquidity portion, needed to fund day-to-day or short-term spending needs
- A core portion, for lifetime goals for you and your family, like income in retirement
- A satellite portion - additional to lifestyle needs and could be used to enhance lifestyle or inheritance planning
Each of these parts of the allocation framework have options to invest sustainably. In the liquidity portion, you can find money market funds. Then, occupying the satellite portion are diversified multi asset funds designed to help meeting lifetime goals, and thematic equity funds like climate change or energy transition.Across the framework there are opportunities to invest in products incorporating exclusion, integration, and engagement practises.
Progress not perfection
As with many things in finance, the industry evolves before the structure of standardisation and regulation comes in. It means that the responsible investment product need was met as it arose. This is good for innovation but not so good for investors (who are not involved in the day-to-day) to understand what they may be investing in.
Regulation in the responsible investing space has enhanced in recent years to help inform investors on what 'good' looks like when it comes to a sustainable approach. The regulation also aims to direct more capital into sustainable investments benefitting all stakeholders, not just shareholders, but it is still a work in progress.
As I mentioned earlier, the industry has moved on from just excluding investments in certain countries and companies to try to improve laggards and it will continue to evolve.
The next big step for the industry is the measurement piece and how sustainability initiatives are reported to investors. We watch this with keen interest as regulation looks to bring more standardisation.
Will I sacrifice returns by putting ESG factors at the fore?
A key question for investors looking to invest responsibly is whether you can still meet your financial aspirations by considering non-financial metrics.
In theory, investing in companies and countries that are repositioning themselves for a more sustainable world should do well in the long term, but it shouldn’t be seen in isolation without a traditional assessment of what makes an investment attractive.
In practice, it really is too early to tell. The industry is evolving. It may well be that in twenty years responsible investing doesn’t stand out from traditional investing as the prioritisation of ESG factors becomes the norm due to investor appetite and regulation.
What we can say for now is that there will be times when a responsible investing approach outperforms. For investors, the key question is whether they believe investing in companies which are contributing to (or are on the path to contribute to) a greener, safer, and more equitable world is aligned with their financial and non-financial aspirations. It should be noted, however, that progress is not linear, and there will be times when patience is needed as with all approaches to investing.
Warning: The information in this article is not a recommendation or investment research. It does not purport to be financial advice and does not take into account the investment objectives, knowledge and experience or financial situation of any particular person. Investors should determine whether an investment is appropriate to their own personal circumstances.
It all begins with a simple, no obligation conversation.