How Do ESG Strategies Differ? Phiroza Katrak

Business management and entrepreneurship studies are awash with the myriad factors which are key to successful strategies, but they broadly include: clarity of ambition, objective and desired outcome(s); achievability and reasonableness of the goal; considering various coherent paths to get there and the discipline in implementing one; accountability and progress measurement.

In that respect, an ESG / Responsible Investment strategy should be no different.  However, what complicates things is that ESG means different things to different people, it can be emotive and difficult to divorce from personal values and priorities.  Nor are there universally agreed and accepted set of ESG definitions and metrics. And this is before you get to regulations, taxonomy and labelling, whether self-determined or third party assessed.  

There is also no homogeny to ESG investing, although avoiding greenwashing is an integral principle.  A lot will rely on investors’ own qualitative and/or quantitative assessment of ESG factors and risks now and over the longer term and aligning the course of action with the intended outcome they wish to achieve.  

The United Nations Principles of Responsible Investment’s (UN PRI’s) suggested method for ESG incorporation when building a portfolio of equity investments is using one or a combination of three approaches in determining sectors and/or issuers for investment.

i. Integration: explicitly and systematically including ESG issues in investment analysis and decisions to better manage risks and improve returns.

In a three-step process of research, valuation and portfolio management, ESG factors are integrated into decision making alongside all other material factors and forecast financials and valuations are adjusted for the expected ESG impact.

ii. Screening: applying non-financial filters to the investable universe to rule companies in or out of contention for investment, based on investor preference, values or ethics. Filters are typically based on particular products, sectors, services or corporate practices.

Norms based screens: These use minimum standards of business practice set by recognised bodies or frameworks, e.g. the UN’s Global Compact and its Guiding Principles on Business and Human Rights (its “protect, respect and remedy” framework), International Labour Organisation’s Conventions, etc.

Negative screens: These avoid or reduce exposure to particular companies with products/services/business practices or to particular sectors with a poor ESG record or are based on the investor’s criteria and parameters.

Positive screens: These include the best performers by ESG performance and/or practices relative to industry peers.

ii. Thematic: directs capital towards investments that contribute to environmental or social outcomes; this approach includes impact investing.

Impact investing, a subset of thematic investing, is explicitly looking to make additional, measurable, positive environmental/social impacts as well as a financial return. To demonstrate the additionality, it also requires adequate measuring and monitoring of the investment’s impact on environmental or social outcomes.

The area of impact investing most often references the UN Sustainable Development Goals (SDGs), and the PRI Reporting Framework.

There are 17 Sustainable Development Goals, encompassing 169 targets. If portfolios or individual investments which aim (or indeed claim) to be aligned with or contributing towards the UN SDGs, then before investing the most basic questions are: What is the outcome contributing to? Can the additionality of the impact be measured?  Who or what will benefit and for how long? How is the outcome better than what would have happened anyway?  

The screening for fixed income securities includes the above and is broadened to include sovereigns, sub‑sovereigns, supranationals and agencies.

ESG investment policies, strategies and approaches aren’t one-size-fits-all. They are nuanced and should be determined through discussion and debate. The objectives, priorities, desired outcomes, approach, timeframe over which any change is expected, the recognition and acceptance of any potential financial impact, should all be clearly understood and expressed.

And finally, let’s not forget stewardship or active ownership where shareholder clout can be used to bring about significant improvement and sustainable benefit for the economy, the environment and society.  It is not an ESG strategy in itself, but a powerful tool to encourage, influence and force change in corporate behaviour and responsibility and better manage and minimise material ESG risks.    

If you are considering thematic fund selection - for example, climate change and transition, clean/renewable energy, sustainability - or aligning funds to your authority’s articulated ESG policy, then then please contact Arlingclose who have experience in this area.

Related Insights:

Regulators Get Tough on Greenwashing

Green Bonds adn Sustainability-Linked Bonds

The ESG Ratings Challange