Investing 'responsibly'
As more people around the world understand the impact of climate change, there is greater pressure on companies to do their bit for the environment.
At the same time, more scrutiny is being placed on multinational companies to ensure that they treat their staff and suppliers in a fair and equitable manner. For example, companies taking advantage of the looser regulatory arrangements that might apply in third world countries can incur harsh criticism in the media if they are found to be breaching labour standards, risking serious damage to their reputation not to mention their share value.
Today, many customers, investors and shareholders are concerned to ensure that businesses show greater sensitivity to environmental, social and corporate governance (ESG) issues.
As a result, an increasing number of companies have begun to assess the financial impact of their environmental and societal risks, in particular, climate change. Serious consideration is also being given to improving sustainable business practices.
Shareholders taking action
As an investor, you may want to invest your money in companies or managed funds that share your own beliefs and values about what is socially responsible. There are a number of ways you can do this, although you will need to so some homework.
There are many new frameworks now in place to help companies chart their progress on environmental, social and corporate governance (ESG) issues.
This information allows investors to make decisions which are based on the company's financial performance as well as its performance on issues which are less tangible such as their impact on the environment and their relationships with staff, suppliers, and the communities in which they do business.
The socially responsible investment industry has grown considerably in recent years. As a result, a range of different methodologies and terminologies have emerged to suit different investor preferences.
Ethical investing, also known as socially responsible investing, is founded on traditional investment practices, but it also takes into consideration the values and beliefs of the person or organisation.
This style of investing may be adopted by individual investors, charities, non-government organisations or religious organisations.
On the other hand, 'responsible' investing starts with the idea that environmental, social and governance issues have a material impact on portfolio value and because of this, they should be integrated seamlessly into the day to day investment process.
This style of investing is adopted by some large government investors or superannuation funds which are often legally precluded from making investment decisions based upon ‘ethics’ due to the inherent subjectivity in such decision-making.
Individual investors and organisations which are values-based are much freer to align their own values with their investment decisions. For example, you may choose to invest only in companies that can demonstrate that they meet international labour standards, making sure that this extends right through to the supply chain. You might refrain from supporting industries that you believe contribute to warfare in some way, or choose to avoid investing in the clear felling of native forests.
Even if you are not actively seeking an investment that is considered to be 'responsible', there are a growing number of Socially Responsible Investment (SRI) and environmental, social and corporate governance (ESG) products on the market that you may come across when choosing managed funds or superannuation.
It's worth knowing exactly what such terms imply and how you can assess these kinds of investment products.
What does the law say?
There are laws governing the information that must be supplied in product disclosure statements (PDSs) relating to labour standards and environmental, social and ethical factors for all SRI products. In December 2003, ASIC released guidelines to this affect (Section 1013DA disclosure guidelines).
In a nutshell, the guidelines state that where labour standards or environmental, social or ethical considerations are taken into account, the PDS must tell consumers which matters are taken into account, and how they are taken into consideration, so that consumers can clearly understand the approach. The PDS must also clearly state where the investment firm does not take such matters into account.
Download the Section 1013DA disclosure guidelines
Socially responsible investing
Socially responsible investing (SRI), also know as 'ethical investing', is about actively exercising choice about the kinds of companies you will or will not invest in based on your own values and beliefs, usually according to issues like labour standards and a variety of environmental, social and ethical factors.
SRI generally refers to three different types of activities:
- SRI may be an option when you consider investing in a managed fund or deciding on options for your superannuation. You can place your money in managed funds, shares, bonds or other securities that are screened to reflect environmental, social or other non-financial values.
- Another way of pursuing SRI is by shareholder action aimed to improve a company’s environmental or social behaviour through the exercise of rights gained as an owner of shares in the company.
- You may, for example, become a shareholder then introduce (or vote on) a resolution at an Annual General Meeting of a company in order to put pressure on a company to behave in what you consider to be a more socially responsible manner.
- Alternatively, a managed fund that holds shares in a company can uses its shareholdings to raise issues with company management and attempt to exert influence this way.
- Community-based investing is another form of SRI that makes direct investments in projects or financial institutions that benefit specific communities or constituencies, especially in economically disadvantaged areas.
Unlike when you make a donation, when you become a community investor, the original value of your investment can be returned, either through payment or trading. You are not necessarily giving your money away.
How are SRI investments selected?
A number of different types of screens are used to select investments that fall under the SRI category.
Typical approaches used in selection of potential investments include:
- negative screening to avoid some types of investments eg gambling, weapons, armaments, tobacco, alcohol or industries that are perceived to have negative impacts on the environment
- positive screening to exercise a preference for activities or desired SRI characteristics, eg companies dealing with biotechnology, renewable energy, and health care, or companies believed to show good environmental and social performance
- 'best-of-sector' screens to select leading firms in every business sector, based on environmental and social performance or sustainability.
Another approach is to use a social responsibility overlay to select funds using traditional financial criteria, but also adding a process for addressing issues related to social responsibility. Some people refer to this approach as an‘engagement’ or ‘confrontation’ strategy, to contrast it with avoidance or preference approaches.
This is how it works: a fund identifies environmental, social or other risks to a company in which it is investing, then meets with the company to discuss ways of overcoming or reducing the risks. By lobbying companies about their social and environmental risks, SRI fund managers actively try to influence companies to have better standards implemented.
Once a company has been screened to be a suitable target for SRI, the next step is to get a clear picture about what it is actually doing in terms of labour standards and all the environmental, social and ethical factors material to its business.
At the same time, the SRI fund must also be clear about what exactly it will and will not invest in, and what criteria will be used to assess the companies that fall into the pool of 'possible applicants'.
This is where things can get tricky. For example, some SRI funds may avoid investing in heavy chemical producers, but still allow investment in old-growth logging. Similarly, a fund may impose rigorous environmental standards when screening potential companies, but neglect to consider social issues.
Further complications may also arise in the supply chain, because a company's suppliers may not always meet the SRI criteria imposed by a fund.
The best way to be sure that your money is being used in a manner that you feel comfortable with is to look at how your SRI fund selects its investments and assess whether this equates with your own values and beliefs.
How do companies demonstrate suitability for SRI?
Many companies today publish corporate documents relating to social responsibility. These include mission statements, codes of ethics, corporate social responsibility strategies, sustainability reports, human rights reports and so on. Companies may also choose to increase consumer confidence in these kinds of documents by having them independently validated by external assessors.
Other tools available to assess a company's suitability for SRI include voluntary indices and benchmarking surveys.
An index measuring non-financial indicators enables a company to measure and publicly report on its corporate responsibility performance whilst comparing itself with its peers. Corporate social responsibility indices also create 'best-of-sector' rankings that provide useful benchmarks for SRI.
There are many indices on the market today and they each vary slightly in their areas of focus. Some are offered for free and managed by not-for-profit entities while others require companies to pay for participation.
Depending on its methodology, an index may engage with the NGO sector on issues like human rights, the environment and industrial relations or be part of a UN initiative.
The best way to find out how well any of these surveys address areas you think are important is to look at their methodologies and make an assessment about whether they meet your own expectations about social responsibility.
At the end of the day, your own values and beliefs about what is socially responsible will guide your investment choices.
Responsible investing
Unlike ‘ethical investing', which uses negative screening to exclude certain stocks from an investment portfolio, 'responsible investing' is a term used to describe a method for mainstream investors to incorporate a wider range of risks and rewards into the investment analysis and decision-making process.
The United Nations has developed a framework that investors and companies can refer to when measuring the environmental, social and corporate governance (ESG) components of a company's performance.
The Principles of Responsible Investing (PRI) identify how investors can consider ESG issues in company performance across a range of areas including
- investment decision-making
- active ownership
- transparency; and
- gaining wider support for these practices from the financial services industry.
Principles of responsible investing (PRI)
When launching the Principles in 2006, the United Nations Secretary-General said they grew out of the understanding that while finance fuels the global economy, investment decision-making does not sufficiently reflect environmental, social and corporate governance considerations or the tenets of sustainable development.
The Principles aim to provide a framework for achieving better long-term investment returns and more sustainable markets. They set a global standard for good responsible investment practice that companies can reference, regardless of the regulatory requirements of their own region. These include strategies for responding to environmental issues, including the impact of climate change, and clear practices in place for workplace safety and good corporate governance.
There are six overarching Principles that are voluntary. These are underpinned by a set of 35 possible actions that institutional investors can take to integrate ESG considerations into their investment activities.
These actions relate to a variety of issues, including investment decision-making, active ownership, transparency, collaboration and gaining wider support for these practices from the whole financial services industry.
Under the PRI, companies are also required to look beyond the immediate concerns of their own business and address issues in the supply chain. For example, if a company is serious about improving its environmental performance, it must ensure that it does so in the broader context of its suppliers, whose actions also impact on its environment and community.
In a nutshell, the PRI aims to ensure that companies who pledge to recognise ESG issues walk the talk: if they fail to deliver their proposed responsible investment initiatives, they can risk their reputation and be accused of ‘greenwash'.
The full text of the Principles for Responsible Investment, as well as an updated list of asset owner signatories is available on http://www.unpri.org.
More information
The Responsible Investment Association Australasia is an industry association that has developed a Certification Program to help investors compare and contrast investment opportunities that take into account environmental, social, ethical and governance considerations as well as financial returns.
FIDO Website: Printed 07/25/2008
