Responsible investing has been growing in popularity in recent years. According to the latest report from the Global Sustainable Investment Alliance, $30.3 trillion (€27.9 trillion) is invested in sustainable investing assets globally. That’s more than a quarter of all professionally managed investment assets worldwide. That represents an increase of almost $8 trillion or 34 per cent on the 2016 level.
However, it is also a drop of $5 trillion on the total recorded in 2020. That fall was mainly due to a reclassification of a large number of investments in the US which were found not to conform to generally accepted sustainability standards. A similar trend is in evidence in Europe, but not quite as pronounced, with a 5 per cent drop in the value of responsible investment funds due to reclassification.
That significant drop has as much to do with difficulties in defining responsible investment as anything else. So, what exactly is it?
“It is very hard to define,” says Daniel Moroney, investment analyst with RBC Brewin Dolphin. “One person’s responsible investing is not the same as another’s. We are now seeing ESG being used quite extensively to describe responsible investing. That helps to define it a little bit better. It’s really about people wanting to invest in companies that are concerned about the environmental and social impacts of their activities.”
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The governance element of ESG is nothing new. “Nobody wants to invest in companies with poor quality reporting or governance structures,” Moroney points out.
While this is still a little vague, the EU has helpfully come up with clear classifications for sustainable investments.
“The Sustainable Finance Disclosure Regulation (SFDR) aims to orient capital towards more sustainable businesses and increase transparency on ESG investing and sustainability among financial institutions and market participants,” says Deirdre Timmons, sustainable finance lead, ESG Reporting and Assurance, at PwC Ireland.
“SFDR product classifications fall under three categories – Article 8, Article 9 and Article 6. Article 8 funds are also known as light green products and promote social or environmental characteristics or both whilst also having good governance practices. Article 9 products are also known as dark green products and have a sustainable investment objective. Article 6 funds have no sustainability focus.”
This will certainly help investors with product choices but there is still the question of greenwashing. How do they or the fund managers know that a company is as sustainable and well governed as it claims to be?
A recent PwC survey found that almost all investors in Ireland (97 per cent) believe that corporate reporting contains at least some unsupported claims about a company’s sustainability performance.
“This is something that could lead to accusations of greenwashing, resulting in reputational damage beyond repair,” says Timmons.
Unsurprisingly, investors want greater transparency, consistency and comparability of information on the material issues facing companies to enhance their investment appraisal. Once again, the EU has come up with a solution.
“The EU’s intent when creating the Corporate Sustainability Reporting Directive (CSRD) was to satisfy those investor needs by creating consistent reporting standards and disclosures, increasing transparency and regulating assurance over those disclosures to ensure accuracy and accountability,” says Timmons.
“Most investors believe that adhering to forthcoming sustainability reporting regulations and standards, including CSRD, the SEC-proposed climate disclosure rule in the US and ISSB standards, will satisfy their information needs for decision making to a large or very large extent.”
These new standards are very important, according to Rahim O’Neill, deputy director of Ibec industry body Financial Services Ireland.
“Ten to 15 years ago, responsible investing was done on the basis of values and beliefs and doing the right thing,” he says. “In the old days it was a question of not wanting to invest in certain things and that was a bit arbitrary. Those days are over. We now have regulatory and technical standards to define sustainable investment.”
The rising popularity of responsible investing is due to a number of factors, O’Neill believes. “There are people who don’t want their pension to be invested in the arms industry and others who might be inclined towards renewables or forestry investments,” he explains.
“There are also institutional investor demands. A pension fund run by the Church of England, for example, may wish to exclude certain types of company. Other institutions may have reputational or other concerns.”
There are also political and regulatory drivers. “It all comes under the umbrella of what the EU has signed up to in terms of the UN Sustainable Development Goals, the Paris Climate Agreement, its own emissions reduction targets, the taxonomy for sustainable activities and the needs of society,” says O’Neill. Responsible investing, he adds, “is only going in one direction”.
Moroney believes a growing appreciation for the gravity of the climate crisis is also at play. “When people are faced with an existential threat like this it really focuses their minds,” he says. “More seasoned investors are looking at the future world they are leaving to their children and those who come after them.”
Performance also comes into play, of course. How do they measure up to more traditional investment strategies? According to Moroney, they have done quite well over the past 10 years or so, but this may have been due to wider market trends.
Growth-oriented companies such as those in the tech sector have tended to do better than traditional funds but it hasn’t all been one-way traffic
— Daniel Moroney, RBC Brewin Dolphin
He explains that before the introduction of Article 8 and Article 9 classifications, responsible investment funds tended to work by screening out companies involved in industries such as tobacco or fossil fuels. These are known as value stocks, where a big part of the investment return comes in the form of dividends.
“If you screen those out, you are left with more growth-oriented companies like those in the tech sector,” he says. “In the last 10 years there has been a tilt towards growth and those stocks have done quite well. By and large, they have tended to do better than traditional funds but it hasn’t all been one-way traffic.
“Renewable energy firms with a lot of leverage on their balance sheets were hit badly by recent interest rate rises and their share prices suffered. In the longer term, it is reasonable to think that Article 8 or Article 9 funds will be geared towards quite profound structural market trends.”