Traditionally investment managers were not concerned about the activities of the companies they invested in. They were only interested in their ability to grow and make profits. However, due to customer demand, a whole new style of choosing what to invest in has evolved. This is known as SRI (Socially Responsible Investing), Impact Investing or ESG (Environmental, Social, Governance) investing.
- Environmental concerns are those around pollution, carbon emissions and bio-diversity for example;
- Social concerns take into account activities like child labour, weapons and pornography;
- Governance covers issues around the running of companies such as the conduct of directors and requirements for financial reporting.
The first ethical fund managers used a method of screening out (and some still select this way). They have a list of prohibited activities and do not invest in any businesses that are involved in them. This reduces the potential pool of companies to choose from and may exclude whole industries. The reduced diversification makes this style of investing more risky, however investors can be certain where their money is going.
There are also fund managers that select investments by screening in. They aim to promote ethical and sustainable practices by supporting only businesses that are either innovating or promoting change through their products and activities. These funds are particularly concentrated across a small number of companies which again increases risk to investors.
As ESG investing becomes more mainstream, a third style is becoming popular with managers. They take the list of companies they could invest in if there were no ESG considerations and then score them using ESG criteria. They then exclude those with the lowest scores (and some may also buy more of those that ranked the highest). This approach gives investors superior diversification, but still means that a portion of their investment may be sponsoring activities that they do not agree with.
An additional complication is that each fund manager has their own list of good and bad activities. Likewise, socially responsible investors can vary widely in what they will and will not tolerate in their portfolios.
An ESG aware financial adviser can tailor an investment portfolio to the specific needs and values of each client. For more information on responsible investing click here.
We are a member of the Responsible Investment Association Australasia (RIAA)
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© Summation Strategies 2017.
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