Sustainability - an Overview
The words ‘sustainable’ or ‘ethical’ in connection with investment means many (different) things to many people but can be broadly defined as using investment strategies which choose investments that are likely to benefit mankind, both in the near and far future. Sustainable investing strives to support industries making a positive impact. Here we take a brief overview of the subject.
Generally, sustainable investment falls under two main headings.
Socially Responsible Investment (SRI)
Environment, Social and Governance based Investment (ESG)
Socially Responsible Investment (SRI)
SRI mostly now refers to ethical or values-based investing, which screens out traditional ‘sin’ stocks, i.e. investments considered to be unethical. Thus, SRI introduces an ethical dimension to investing, often involving negative screening of investments. SRI typically involves either one or both of the following:
‘Screening’ which excludes investing in companies which produce, for example weapons or tobacco. There are examples which do not make the investment decision black and white. An investor would need to decide whether energy companies that deplete natural resources and contribute to global warming are allowed in an SRI portfolio if the company is also developing renewable energy technologies.
Shareholder advocacy and engagement where institutional investors seek to enact constructive change in investee companies by encouraging wider corporate responsibility or sustainable practices through engagement and thoughtful proxy voting.
‘Stewardship’ is widely used in this context and a Code applies principles for Fund Managers. The Financial Reporting Council published a Stewardship Code in 2010 which includes many of the principles mentioned in this narrative.
In practice, ‘screening’, ‘shareholder advocacy and engagement’ and ‘Stewardship’ are not mutually exclusive; being regularly used together, and it would be unusual for an active SRI fund to do, for example, ‘screening’ without ‘shareholder advocacy and engagement’.
Environment, Social and Governance Investment (ESG)
On the other hand, ESG integration examines the impacts of a wider set of characteristics and themes impacting the performance of companies.
ESG often takes an agnostic approach to ethics unless it causes reputational damage or is eroding its social license to operate.
Some ESG factors are:
Environmental issues, these may include climate change, hazardous waste, nuclear energy and sustainability in general.
Social concerns may include diversity, human rights, consumer protection, company culture, human capital and animal welfare.
Governance may include management structure and quality, shareholder rights, Director independence and remuneration, Board skills and executive compensation.
Sustainability – ‘Ethical’ Investment - How this Affects Our Advice
We start by finding out what you want, such as growth of funds to be invested, with or without income distributions, timescales, benchmarks for measurement, taxation preferences and other criteria. We in this context also consider your personal views on sustainability including ethical aspects. We then balance these factors and provide a report which indicates a portfolio - weighted optimally.
It is important to note that we do not judge clients – we have many clients who have given us no steer on this subject yet choose to serve society in their own chosen ways.
Our system for constructing investment portfolios uses a variety of matched funds suitable for client needs. These funds are chosen not on individual performance but as team players using correlation as the driver – https://www.sjohnsonwm.co.uk/post/correlation correlation allows us to manage the likely risk of the portfolio.
Funds chosen – our system: Leading on from the previous paragraph our client portfolios consist typically of ten or more funds. Each fund is run by a Fund Manager who is responsible for selecting the underlying investments. There are often more than 50 underlying investments (direct holdings) in each fund. The funds produce explanatory information in the form of Key Investor Information and other documents which indicate the funds objectives and investment criteria. We and other advisors rely on the Fund Managers concerned since we have no way of monitoring underlying changes of holdings and their compliance or otherwise with their stated objectives, however legislators also have significant control and are likely to clamp down on ‘greenwashing’.
It is possible to construct portfolios exclusively using only SRI or ESG funds, but it is important to note the comments in paragraph below. As an alternative to our approach those with significant amounts to invest can instruct stockbrokers to select individual specific companies based on their requirements, however again the comments below apply.
We are increasingly being asked about sustainable investment and we do understand why. Where a prospective client specifies that a significant proportion of (their) holdings be in ethical holdings such as SRI or ESG funds this inevitably restricts our scope of action, and this loss of diversity often will result in an overall increase in the level of risk taken over a more conventional approach – we will listen to your and only if we feel that we can provide the right level of service and advice at the correct risk profile that meets your needs will we act for you.