What Is Responsible Investment
What is Responsible Investment?
Responsible investing (RI) is an investment strategy that integrates both financial and non-financial factors into the valuation, management and selection of assets and risks. RI offers a more representative rate of return than traditional investment approaches that focus solely on financial performance, by including consideration for the environmental, social and governance (ESG) performance of assets. Within the overarching RI strategy, there are several approaches to integrating ESG into investment decisions and practices. They are often categorized into the following ‘three pillars of RI’:
- Screening (positive ‘best in class’ or negative): Eliminate risk from a portfolio or to take advantage of opportunity that a purely financial risk analysis would fail to capture.
- Proactive investing (economically targeted investments, community investments, mission-related investments): Generate a financial and social and/or environmental rate of return (e.g. affordable housing, renewable energy.
- Corporate Engagement (Proxy Voting, dialogue, media campaigns, threat of divestment) An ownership approach that focuses on actively influencing companies within an investment portfolio to improve their ESG performance.
For an overview of these approaches to Responsible Investing, see the Shareholder Association for Research and Education’s Publication:
Putting Responsible Investment into Practice, A Toolkit for Pension Funds, Foundations and Endowments
Investors acting on behalf of shareholders have a legal obligation (fiduciary duty) to act in the shareholder’s best interests. The traditional understanding of shareholders’ ‘best interests ‘is defined in financial terms and largely ignores non-financial characteristics of investments. But there is a growing consensus in investment management literature that fiduciaries not only can, but must include non-financial considerations as part of their due diligence.
This view is also gaining traction among legal experts. The UNEP FI Asset Management Working Group (AMWG) in cooperation with Freshfields Bruckhaus Deringer, an international law firm, released two reports on Fiduciary responsibility. The reports outline a legal framework for integrating ESG issues into institutional investments. They argue that it is not only possible, but necessary that investors adapt to this evolving definition of fiduciary duty. Trustees who fail to consider the potential impact of ESG issues on the long-term performance of investments could be in breach of their fiduciary responsibilities.
Closely related to the legal case for RI, the business case is supported by evidence that suggests non-financial (ESG) risk factors must be incorporated into the investment analysis in order to optimize financial returns. Critics of the investment approach argue that by limiting an investor’s investment universe, divestment and negative screening approaches result in sub-optimal financial returns. But there are other approaches available to incorporating ESG risk factors into investing and mounting evidence supports a positive link between corporate social performance and corporate financial performance. See our CURI series entitled: ‘Financial ESG: investment risks and opportunities‘
While the business case for RI has received a lot of hype over recent years, the origin of the investment approach is rooted in ‘moral’ grounds. In particular, faith based organizations such as the Interfaith Centre on Corporate Responsibility (ICCR) have been instrumental in promoting an investment approach that seeks to align the values of the organization with its investment practices and decisions. These investors chose to screen their investments to avoid supporting corporations that peddled services and products that were harmful to society and the environment, commonly referred to as ‘sin stocks’. But this investment approach has evolved over time to include more complex expressions of investor preferences, through engaging with corporations on ESG issues.
Why It Matters For Universities
The legal, business and moral cases provide complementary and compelling reasons for universities to adopt a RI strategy. Universities bear a great deal of responsibilities within society. They are responsible for the creation and dissemination of knowledge and the instruction of technical skills. Universities are also often described as ‘training grounds for emerging citizen leaders’. In order to accomplish these goals, society grants universities a great deal of autonomy and resources.
CURI believes that endowment and pension funds should be invested with the University’s purpose and values in mind. Universities must ensure that their investments incorporate intergenerational equity principles. Yale was one of the first institutions to formally identify the ethical responsibilities of the university as an institutional investor, publishing in 1969 ‘The Ethical Investor: Universities and Corporate Responsibility ‘.
Examples and Best Practices
To date at least thirty-four colleges and universities in the United States have established committees on responsible investing, which provide advice regarding investment of the university’s pension and endowment funds. Check out the Responsible Endowments Coalition for more information on U.S. universities.
RI is gaining traction across Canadian universities, who are beginning to engage more actively in responsible investing initiatives that extend beyond responding on an ad hoc basis to divestment campaigns. As mentioned above, there are several approaches to incorporating a Responsible Investing strategy at your university and while there is no right way to implement RI, it is important that the process is transparent and provides opportunity for stakeholder involvement. One of the best ways to accomplish this is by establishing a Responsible Investing Committee, like students have at the University of Toronto.