Sustainable investing can be a confusing concept. That’s because it covers a range of different investment styles and there is a lack of clear definitions.
The spectrum of capital as outlined here by Karen Shackleton is a useful framework to gain a great understanding of sustainable investing. This represents a continuum with traditional return-only focused investing at one end and philanthropy at the other.
The style most closely aligned to traditional asset allocation is defined as responsible investing. Risk mitigation is the philosophy driving these approaches. The aim is to avoid those companies which have bad environmental, social or governance (ESG) practices.
This approach is particularly popular among large institutions which have allocated to equities by tracking a world index. A large number of these asset owners are shifting towards an index which screens companies’ ESG characteristics and tilts towards those with the best scores. This allows them to avoid the risks associated with companies which do not have strong scores.
It’s unhelpful to have sustainable investing as one of the styles in the spectrum of capital as this is my preferred umbrella term for this way of allocating assets. But it does help to explain why so many feel confused!
To be a sustainable investor, it’s not enough to just worry about risks; managers of these funds want to create positive outcomes for people and the planet. Simply tilting a fund towards companies with a high score is not going to achieve this aim; a more active approach is needed.
For example, a manager may invest in those companies with less than perfect ESG characteristics and then engage with corporate boards to improve their behaviour and those scores. If successful, they will create a positive outcome for people and the planet.
This style of investment takes these goals one step further and specifically aims to have a positive impact not just on people but those who are underserved. Some managers achieve this by linking their investment aims to the UN’s Sustainable Development Goals. One of these goals is the provision of affordable and clean energy.
This can be achieved by investing, for example, in an oil and gas major and persuading it to adopt net carbon zero goals as well as investing in greener technologies which could be located in the developing world.
Managers can achieve these gains through effective corporate engagement. A number institutional investors and asset managers banded together to form Climate Action 100+ and persuaded BP to adopt net zero targets by 2050.
They could also incentivise corporate boards by offering more favourable investment terms, such as lower interest rates on loans, if the company improves its behaviour or takes steps to address its environmental record in badly polluted areas of the world.