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10 August 2016updated 09 Sep 2021 11:02am

There’s more than one kind of return

There doesn't have to be a trade-off between your morals and your bank balance; sustainable investment actually makes solid business sense, as Fergus Moffatt explains

By Fergus Moffatt

Reflecting values in the way business is conducted or money is invested is not new. ‘Responsible investment’ can trace its roots to 18th century Quakers who were prohibited from participating in the slave trade.

Investors have come a long way since then. Over the past 25 years we have witnessed sustainable and responsible investment (SRI) moving from a niche to an increasingly mainstream approach for retail and institutional investors. The most recent European SRI study shows the UK as being the biggest market in Europe, second globally only to the US, and SRI is on the agenda of more institutional asset owners and fund managers than at any time for 30 years.

In part this is because of positive policy developments in the UK over the past few years. A Law Commission review into the concept of “fiduciary duties” in certain types of pension funds was a welcome step in promoting SRI. It said that those funds should consider factors like climate change, human rights or executive remuneration where they are financially material. The Law Commission’s view was adopted earlier this year by The Pensions Regulator in guidance, and in making new rules for the Local Government Pension Scheme the government has set similar criteria.

Yet one of the biggest challenges faced by the sector is defining exactly what sustainable and responsible investment means. Vicki Bakhshi, head of governance and sustainable investment at BMO Global Asset Management explains that for those considering their options, a key element is to understand the different ‘styles’ of responsible investing.

“If the aim is to avoid certain activities that conflict with morals or principles – such as tobacco or weapons producers – then ‘ethically screened’ or exclusion- based funds are the way to go.

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“If the focus is more on picking the companies that are the sustainability leaders of the future, then look for a fund with a thematic orientation, focussed on sectors such as healthcare, clean technology or natural resources.”

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She explains that the two approaches are not mutually exclusive. Some funds – including BMO’s own Responsible Global Equity fund – combine the two.

In October polling commissioned by UKSIF for Good Money Week showed that 54 per cent of people with investments wanted both a financial return and a positive social or environmental outcome. Yet Bakhshi highlights the fact that despite a trebling of retail ethical assets under management over the past decade to £15bn, this represents only 2.5 per cent of the overall UK retail market.

So why aren’t people putting their money where their mouths are? Part of the reason is a view that responsible investment involves trade-offs.

“People care about sustainability, yes, but they also want a secure pension. The good news is that there is now compelling evidence that not only is the trade-off a myth, but that caring about sustainability actually makes good business and investment sense. Companies that treat their workforce well, have systems to manage their environmental impacts, and have strong, empowered Boards are just good companies, and are more likely to be a more sound long-term investment proposition than those who neglect these issues and subject themselves to unnecessary risks. Increasingly the academic evidence backs this up. The University of Oxford reviewed over 200 studies, and found that 88 per cent showed a positive link between strong management of environmental, social and governance (ESG) issues and company level operational performance.”

The idea that companies which take SRI issues into account are better governed and therefore better long term investments is one that has gained traction in recent years as more data has become available. For the SRI sector this means properly pricing externalities. Incorporating SRI concerns into investment processes enables investors both to mitigate risk and seize opportunities. Proactively addressing these issues leads to benefits for investors, and rewards more sustainable companies.

This is a sentiment that Charles Clarke, head of communications at HSBC Global Asset Management shares: “Companies which have a clear understanding of the key sustainability challenges their business faces, both in terms of risks and opportunities, and who have taken the appropriate steps to manage these challenges are better placed to deliver superior returns to their investors. But this does not necessarily mean that SRI funds will outperform the rest of the market as investment performance is comprised of a number of aspects such as factor exposure, portfolio manager judgement or currency.”

Following the COP21 climate summit in December, we have seen investors focus more on the challenges presented by increasing global temperatures. According to the International Energy Agency, over US$16tn will be needed over the next 15 years if signatories to the deal are to meet their commitments. Governments cannot afford to pay the bill and are looking to private finance. Significant capital will be needed to replace fossil-fuel power stations with zero-carbon sources of energy including wind, solar and nuclear. This is the kind of opportunity responsible investors are well placed to exploit, and Clarke explains that this has been reflected in the market.

“Climate-change-themed products which have limited their exposure to fossil fuels have benefitted from the decline in the oil price as they had fewer energy firms in their portfolio. In the run up to COP21, climate-change related products saw a lot of interest, as did funds which can incorporate the Sustainable Development Goals (i.e. the closest thing the world has to a ‘business plan’) into their portfolios to some extent.”

Demand for climate-related products may well be driven by Millennials, the generation born after 1980. UKSIFcommissioned polling shows that 52 per cent wanted the option of investing fossil free (compared with 26 per cent for over 45s) while a Standard Life Investments poll found over half of 18-24 year olds want their investments to minimise environmental damage.

Amanda Young, head of responsible investment at Standard Life Investments said she has seen a growing demand for understanding how the environment, as well as human rights, labour and business ethics are considered within investment strategies. “Our research into what is driving the younger generation of investors has demonstrated a direct link between youth and values. The younger the investor, the higher the demand for the companies we invest in to be delivering positive benefits for society.”

According to Department for Work and Pensions figures, automatic enrolment into workplace pensions means that by 2020 there will be 9 million more people investing for retirement. Many will be millennials and providers have the opportunity to create new products to satisfy the demand for investment which benefits society.

Samuel Mary, ESG research analyst at Kepler Cheuvreux, has some top tips for savers looking to invest responsibly. “First, responsible investing isn’t only about screening out controversial companies and sectors as per ethical criteria,” he said. “This is a diverse place, with as many approaches as investors’ preferences. Second, ensure you know your priorities. Clearly state both your sustainability and financial goals, which will help to determine the most suitable strategy. And remember that climate change remains the most mature and rapidly developing theme.” For more information visit