What is Responsible Investment?
The term “Responsible Investment” or RI refers to investment approaches that incorporate financial and non-financial considerations into the valuation of investments, choice of assets and ownerships practices. Non-financial issues are often understood as the material impact of environmental, social and governance (ESG) factors on the future long-term performance of investments.
Investors and asset managers have taken several approaches to incorporating ESG considerations into their practices, which vary depending on the characteristics, objectives and values of the investor. The model below captures the range of options available to investors to incorporate ESG into their decision making processes and actions (model adapted from Euorsif and the Bellagio Forum, 2006).
Positive and Negative Screening
Investment screening is a process by which investors evaluate positive and negative criteria to select or reject investments. To implement investment screening, universities can establish their own criteria for all or part of their portfolio. The advantage of developing screens is that they can provide an explicit methodology that allows trustees to differentiate between investment options. Once a University develops screening criteria for its investments, it can simply communicate the policy to its investment managers. However, a sensible screening policy would also allow the trustees the flexibility to deviate from the stipulated guidelines when the application of the criteria is not in the best interest of the University.
Negative screening consists of excluding or barring investments in certain companies, economic sectors or even countries due to concerns over ESG issues. Negative screening is often considered the genesis of the RI movement as religious investors started excluding investments and so-called ‘sin stocks’. Investments typically included in negative screens are: gambling, tobacco, pornography, armament and nuclear weapons.
Positive screening, on the other hand, refers to the selection of stocks of companies that perform best against predefined criteria. Depending on the interests of investors, positive screens may encourage investment in companies that need certain standards or that focus on sectors which are perceived to promote investors’ missions and values. Positive screens may include, for example, investments in renewable energy, sustainable for string or community development initiatives.
Through shareholder engagement, investors actively seek to influence the behaviour of corporations within their investment portfolio to improve their ESG performance. The goal of engagement is to create a constructive dialog with companies to address ESG risks and thereby improve long-term corporate performance.
Investors using engagement strategies often assume an incremental approach to communicate with corporate management with issues that might affect the long-term value of their investments. Shareholder engagement on ESG issues has become an increasing phenomenon, partly fuelled from a proactive shareholder interest to identify and mitigate ESG issues. Engagement also arises as a reactionary dialog after a corporate scandal to prevent further injuries from happening in the future.
Engagement frameworks have resulted in the formation of dynamic and practical collaboration schemes among institutional investors, particularly among institutions with strong social mandates. A significant feature of engagement as an RI strategy is that it does not require fundamental changes in the selection of investments. Engagement keeps investment options open and only takes place after shareholders identify a need to address ESG risks in the businesses in which they invest.
When investors purchase preferred shares of public companies, they also obtain a proxy that gives them the legal right to vote on a number of shareholder and management proposals. When a corporation’s shareholders come together at the annual general meeting, the voting of proxies gives them an opportunity to collaborate with other investors to pursue common interests, address ESG risks and ensure long-term shareholder value. A central notion of proxy voting as an RI strategy is that trustees and their agents have a legal obligation to ensure that the voting of proxies is done in the best interest of the fund’s beneficiaries.
In the past, there has been little interest on behalf of asset owners in voting at shareholder meetings and most investors tended to vote along corporate management recommendations. This tendency is changing, particularly as shareholders recognize that voting rights represent an important tool for communicating expert patients to corporate management on key ESG issues. For many investors, proxy voting also represents an initial approach to implementing RI practices.
Mission Investment and Community Investment
Many investors employ activities generally known as ‘mission investment’ and ‘community investment’ to align their financial objectives along with non-financial goals. These terms refer to investment approaches in which asset owners strategically allocate their resources to further their economic interests while also generating positive social and environmental impacts. To accomplish this, investors regularly adopt a triple bottom-line framework to evaluate corporate performance, not only in terms of financial benefits but also positive social and environmental impacts.
‘Mission investment’ (MI) is a strategy that seeks to align an institution’s investments with its mission. Mission-related investments provide institutions –such as charitable foundations, pension funds and university endowments— additional mechanisms to leverage their financial resources to further their mandate. Among the main objectives institutional investors may pursue through mission investing are: a closer alignment of investment practices with institutional mandates, a wish to recover or ‘recycle’ endowed funds for future use, and, the ability to generate social and environmental benefits that grants and other philanthropic activities cannot.
Community investment, on the other hand, is a strategy in which investors and lenders supply capital to communities (or initiatives) that are underserved by conventional financial markets. Community investments often filled gaps in traditional financial markets by providing access to credit, equity, capital and basic banking services to otherwise marginalized sectors. Investors engage in and community investing may profit from the opportunities created by market inefficiencies while also generating additional benefits to the recipient communities of those investments. Community investments may focus on a wide range of activities that seek to improve the quality of life for individuals, communities and the environment. For example, community investments may provide the necessary capital for initiatives addressing issues such as affordable housing, health services, childcare, social enterprise and in increasingly, issues related to sustainable development, such as reduction of carbon emissions, development of green technologies and renewable energy.
The threat to divest of securities that fail to meet financial and/or ESG standards is an additional tool to influence corporate practices. This is strategy has been relatively familiar to University administrators since the 1980s when several institutions adopted divestment policies from companies perceived to advance the apartheid regime in South Africa. More recently, strong student activism has engaged in highly visible divestment campaigns on controversial issues such as tobacco, Sudan and Darfur. Increasingly, however, the effectiveness of divestment efforts have been questioned and are usually regarded as the last resource to address poor corporate practices and protect investment returns.