Sustainable investing is primarily concerned with Environment, Social and Governance (ESG) factors, with the goals of positive ESG outcomes, and long-term financial returns.
While most of us are familiar with environmental and social issues that are important to us, sustainable investors recognize governance as a key driver of an organization’s environmental and social performance. Organizations that are governed to evoke positive change are ones that encourage transparency, executive diversity, anti-corruption, and corporate political involvement.
Approaches to Sustainable Investing
Sustainable investors assess organizations not only on financial performance, but on a broader scale including how they contribute to creating positive change.
Investment firms generally approach sustainable investing through a combination of the following approaches:
- ESG Integration – Assesses an investment using both ESG factors and traditional factors such as financial metrics.
- Exclusionary Investing – Excludes companies whose revenues are sourced from unsustainable practices (i.e. mining fossil fuels).
- Inclusionary Investing – Seeks highly ranked companies in their sector based on sustainability criteria.
- Impact Investing
Focuses on companies with a strong intent to make a positive environmental impact on an issue that is valuable to the investor.
A common misconception is that companies need to sacrifice their profits to effectively create positive ESG outcomes. However, the expectation with sustainable investing is that by focusing on the long-term, even at the expense of the short-term, there will be greater profitability in the future. According to a study by NYU analyzing over 1000 studies, 58% displayed a positive relationship between ESG and financial performance. The study had also found that the improved financial performance due to ESG becomes more prominent over a longer time horizon, with a long-term focus being 76% more likely to have a positive or neutral result. This is evidence that sustainable business practices are value accretive to investors.
ESG Data Providers
ESG data providers play a major role in the investment process by gathering, accessing and scoring companies on their ESG practices. As of 2016, there were more than 125 ESG data providers, among them are well-known providers with global coverage such as Bloomberg, FTSE, MSCI and Sustainalytics. The development of these rating systems has helped grow sustainable investing, by providing asset owners and managers with an alternative to conducting the diligence themselves.
Reporting Standards and Frameworks
Reporting standards help to guide entities when making sustainability disclosures and promote comparability of data across businesses. Through the collaborative efforts of organizations focused on developing these reporting standards and frameworks, the International Sustainability Standards Board (ISSB) has emerged to service the sustainable finance ecosystem and move ESG from the fringes of investing to the forefront.
In March 2022, the ISSB has launched its first two proposed standards: IFRS S1 – General Requirements for Disclosure of Sustainability-related Financial Information and IFRS S2 – Climate-related Disclosures.
ESG certifications have grown in prominence with the progression of sustainable investing.
The UK Stewardship Code is a voluntary code, aimed at encouraging active monitoring of corporate governance in the interest of beneficiaries. Stewardship in financial reporting refers to the accountability of directors, management, and owners. The code sets high stewardship standards and comprises a set of principles for asset owners, asset managers, and service providers.
The United Nations Principles for Responsible Investment (UNPRI) were created with the intention of signatories contributing to developing a more sustainable global financial system. The principles are voluntary and offer an array of possible actions for incorporating ESG issues.
The Responsible Investment Association (RIA) is Canada’s industry association for responsible investing. Responsible investing (RI) refers to the incorporation of ESG factors during the selection and management of investments. The RIA providers investors with information regarding RI, up to date news on RI in business today, and opportunities to earn an RI credential.
Other notable certifications include: The Sustainability Accounting Standards Board’s (SASB) Fundamentals of Sustainability Accounting (FSA) credential for finance professionals, and the CFA institute’s Certificate in ESG Investing.
Sustainable investing has become increasingly relevant as more and more investors choose to allocate their investments in a way that aligns with their values. Businesses also face more restrictions and limitations, incentivising them to operate more sustainably. In the recent 2021 United Nations Climate Change Conference, over 20 governments including Canada, the US, and the UK agreed to end funding of fossil fuel development projects, and over 100 countries joined a pledge to reduce methane emissions by 30% before 2030.
As sustainable finance gains momentum, investors could look to incorporate ESG investment criteria to make decisions that align with both their financial and non-financial values.
Sureka Namasivayam is pursuing her B.BA. in Accounting and Finance at the Schulich School of Business, York University.
This article is re-published from the Spring 2022 issue of “Street Talk”, TiF’s flagship publication. Interested in writing for us? Click here for our submission guidelines.