ALIGNING WITH SUSTAINABLE INVESTING
On April 22, the world will mark the 51st Earth Day. This year’s theme will be Restore Our Earth. It represents a chance to learn about the environmental challenges we face today, ways to become more involved, and ways to align one’s personal choices in order to make a positive impact.
Many of today’s headlines—numerous severe weather events, continued deforestation, and increased concern with plastic pollution—are part of key environmental megatrends: climate change, natural resource scarcity, and pollution. Investors keeping an eye on these headlines are increasingly aware of an investment mandate that approaches these megatrends through a different lens. Not only does sustainable investing help fortify returns with its unique focus on risk management, it also aligns an investor with investee companies seeking to improve their environmental, social, and governance (ESG) impacts. These environmental megatrends require one to consider how their personal choices can positively impact these challenges. Increasingly, sustainable investment portfolios can provide increased transparency, align with investee companies that publicly disclose their efforts to improve their ESG impacts, and utilize asset managers that fulfill a stewardship role by holding investee companies accountable to improve their ESG impacts.
FRAMING TODAY’S ENVIRONMENTAL CHALLENGES
Today’s environmental challenges are substantial. According to the Intergovernmental Panel on Climate Change, the impact of 1.5°C of warming would disproportionately affect disadvantaged and vulnerable populations through food insecurity, higher food prices, income losses, lost livelihood opportunities, adverse health impacts, and population displacements. It is estimated that the global economic damages of climate change for increases of 1.5°C or 2°C will be $54 and $69 trillion, respectively.1 Unsustainable pressures on natural resources, including population growth, longer life expectancy, economic growth, and increased consumption in developed and emerging countries, threaten continued degradation of nature. According to The Lancet, pollution is the largest environmental cause of disease and premature death in the world today.2
The transition to a low-carbon, more sustainable, and cleaner economy entails both risks and opportunities to business activities. The risks to high-emission businesses are more obvious. However, the risk from supply, operational, and resource management issues are more complicated and will require increased transparency. For example, companies are increasingly expected to understand, manage, and disclose their supply chain risks (i.e., carbon emissions, resource sourcing and usage, waste, employee treatment). Failure to do so will lead to operational, reputational, and financial risks, including stock price performance.
OVERVIEW OF SUSTAINABLE INVESTING: A WAY TO MAKE AN INVESTMENT IMPACT
Responsible investing, or sustainable investing, is the explicit inclusion of ESG risks and opportunities in investment analysis. This investment approach allows for increased:
• Awareness of what’s in a portfolio, through the process of ESG Investing,
• Alignment with what matters to the investor, through the use of screens and ESG integration, and
• Accountability on the part of the asset manager to act as a steward of the investor’s assets, through active engagement with the investee company.
As shown in [Figure 1], sustainable investing mutual funds and exchange-traded funds (ETFs) continue to attract record flows from investors.
ESG investing intentionally assesses the implications of environmental risks and opportunities on each investee company in a portfolio. Many asset managers explicitly seek to integrate ESG factors into the investment process to understand and lower investment risk.3 For example, an asset manager may have a research process that systematically requires the evaluation of company data on issues such as emissions, energy management, waste management, customer welfare, labor relations, materials sourcing, and supply chain management. If an asset manager is considering to add a food manufacturing company to their portfolio, they can use this data to create a scorecard and identify those food manufacturing companies that score best on these issues.
Asset managers can utilize increased awareness from ESG investing to decide whether to avoid, reduce, or increase exposure to an investee company. This process helps an investor align with an improvement story—investee companies that are intentionally striving to improve their environmental impact. For example, to limit carbon exposure in a portfolio, an asset manager may avoid all carbon extracting companies (i.e., oil or coal), or, using the scorecard approach, the asset manager may only include those companies that have the best environmental scores, which is known as a “best-in-class” approach.
Asset managers can act as stewards by engaging with an investee company to help address environmental relative risks. Through engagement dynamics of building relationships, enhancing knowledge, and exchanging information, this stewardship role helps hold investee companies accountable to improve their environmental impact. Returning to the scorecard example above, the asset manager identifies a food manufacturer that scores poorly on its supply chain management relative to its competitors due to its relatively high emissions and poor resources utilization. The asset manager could then engage with the company and work to get commitments from company management to reduce its emissions and seek more sustainable resource utilization in its supply chain.
Read the Guide To Sustainable Investing.