What RI approaches are available for investors?
Given the enormous scope for RI strategies, it can be a daunting task to unpack all the details around them. The range of responsible investment options can be broadly categorised into three buckets; screen, integrate and impact. These three approaches cover the full investment spectrum and also reflect the increasingly refined investment approach evident in RI’s ongoing development.
This is the first step into the world of responsible investments. Various forms of screening create a starting point for embedding ESG. Initially designed to avoid ESG risks by excluding exposures that conflict with investors’ principles and values such as controversial weapons, palm oil or coal, screening now goes much further than simple ‘exclusionary’ or ‘negative’ filters.
A focus on ESG scoring means the portfolio can be evaluated in terms of its exposure to both ESG risks and opportunities. Every bond and stock can receive an ESG score that is aggregated to form an overall ESG portfolio scorecard. This means investments can be viewed in a broader ESG context. Alongside the screening and scoring, an active approach towards stewardship through voting and engagement is an important part of the assets being deemed ESG-embedded. Active voting and engagement is an effective way of encouraging companies to move towards best practice or initiating change on important issues at board level. ESG Embedded is where you can also start to report on key performance indicators (KPIs), such as carbon footprint, which form the basis of a clear ESG measurement framework.
These investments go a step further. This approach uses ESG analysis, including the ESG score outlined above, and incorporates this information into investment decisions.
ESG integration is perhaps the most complex of all RI approaches. While each company is analysed on an ESG basis, there are no perfect companies, so it is not a simple exercise in the same way as an exclusionary screen may appear in its bluntness.
In this case, companies are assessed on how they are positioned to handle both short and long term ESG risks - as well as opportunities. The expectation is that management teams taking decisions to address and minimise ESG issues are likely to be more competitive relative to their peers in the long term. This type of analysis will be very different depending on each company and the industry it operates in, and therefore results in placing companies on a sliding scale in order of preference, rather than creating a simple binary choice.
For example, Coca-Cola1 is a company that you may not necessarily expect to appear in an ESG-integrated portfolio. Health concerns around obesity rates, water management and efficiency are all ESG issues that could affect the long term sustainability of the business. However, Coca-Cola is also an example of a company that has responded to ESG concerns around its core product and wider practices. Through a series of initiatives, such as increasing low or no-calorie products and developing its water risk management programme, it has retained trust and support from investors.
In this way, ESG integration is a world away from viewing companies in just black and white and is perhaps better considered as seeing investments in colour.
Used in conjunction with financial analysis, it aims to create a clearer, longer term picture of a company’s future prospects. The ultimate aim of employing this approach is to create a portfolio of strong ESG holdings which are more likely to outperform their peers with lower ESG scores operating in the same industry.
The most recent phase in RI’s evolution is impact investing. This takes the latest RI techniques and refines them to specifically target positive change. The approach should not be confused with philanthropy – rather, it has two clear objectives. Impact investments simultaneously seek to deliver competitive financial returns while at the same time producing positive societal impacts. Importantly, positive impacts must be measurable and quantifiable. In this way it seeks to harness the power of finance and direct it to solve complex social and environmental problems.
Impact investments can be used in a range of different projects, such as improving access to education and healthcare, expanding the reach of financial products to underserved populations, or reducing the effects of climate change. These are all examples of positive change that can be achieved - in conjunction with financial returns - through impact investing.
In order to deliver on both financial and societal criteria, target outcomes from these investments should be clearly identified from the outset and be specific and measurable.
Because of this strict criteria, the traditional area for impact investing has been in alternatives, like private equity. However demand is building for publically listed equities to play a role. In order to maintain integrity around impact investing, products and services should be considered that go beyond a simple analysis of a carbon footprint compared to a benchmark. Listed equity or fixed income portfolios will need to be constructed with a focus on holdings which can demonstrate that they are making a positive contribution either through quantifiable metrics or active engagement.
Ultimately, impact is the most forward looking segment of responsible investing. It seeks to create an investment virtuous circle by financing projects that promote a better society, in an environment where companies and industries, delivering long-term and sustainable value creation, can flourish.
Source: 1For illustrative purposes only, no representation is made that AXA IM has or is invested in such security.
Important Backtest Disclosures
The backtested portfolio characteristics shown were created using a computer program to estimate the characteristics the referenced model(s) “would” have produced during the timeframe shown as applied to the referenced dataset. The backtested characteristics were created using investment models and/or data that were not necessarily available in its current form to AXA Investment Managers during the timeframe shown. The backtested characteristics were not verified by an independent calculation agent.
Backtested characteristics are not an indicator of characteristics or portfolio performance that would have been achieved, whether in the past or in the future, and should not be interpreted as an indication of such performance. Actual characteristics achieved for client accounts may be materially different than backtested characteristics because the latter is achieved through the retroactive application of a model designed with the benefit of hindsight. As a result, the model theoretically may be changed from time to time and the effect on characteristics could be either favorable or unfavorable. Backtested characteristics representing output from a research project may differ from actual portfolio characteristics because the investment strategy and/or models may be adjusted at any time, for any reason, and can continue to be changed until desired or better results are achieved.
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