RI (also known as Socially Responsible Investment – SRI) takes social and environment factors into account in selecting and managing a portfolio of companies.
There are several ways in which this is done:
Each of these should also be accompanied by active corporate governance.
These terms can be confusing and make it difficult for investors to know what’s real rather than greenwash. Mindful Money uses certification processes and objective criteria to provide guidance to investors about which investments they can trust.
Forms of Responsible Investment
Screening out undesirable companies (also known as ethical investment) is not new. The Quakers refused to support companies engaged in the slave trade 300 years ago. A boycott of companies invested in South Africa was a key part of the anti-apartheid movement.
In 2016, New Zealand holders of Kiwisaver accounts were shocked to hear that some of their money was being invested in corporations making landmines or cluster bombs, nuclear weapons or tobacco. Under public pressure, the managers of most Kiwisaver funds excluded arms and tobacco from their portfolios – this is called sector exclusions or negative screening.
In New Zealand, exclusions of tobacco and controversial weapons (landmines, cluster bombs and nuclear weapons) are now widely used, but not by all funds. Other forms of negative screening exclude companies that derive profits from:
- Pornography/Adult Entertainment
- Exploration and production of fossil fuels
- Distribution of fossil fuels or use of fossil fuels to generate electricity
- Nuclear power
- Labour exploitation
- Genetic Engineering
- Animal cruelty
- Palm Oil
- Human Rights violations
- Handguns and other weapons
- Investments in specific countries or territories
Fossil fuels have been the subject of a strong global campaign, led by the climate change campaign group 350.org. It has helped persuade investors to divest US$6 trillion from companies involved in fossil fuel exploration and extraction. A sign of the campaign’s success came when a trust originally founded from oil money (the Rockefeller Brothers Foundation) divested.
By mid-2018, around US$6 trillion has been divested worldwide. In New Zealand, divestments have included Anglican and Presbyterian churches, Otago and Victoria Universities, and Auckland, Christchurch and Dunedin Councils. Investors can opt to put their money into Kiwisaver and investment funds that exclude fossil fuel exploration and extraction (see forthcoming Mindful Money report).
There has been huge growth worldwide in analysis of the Environment, Social and Governance (ESG) performance of companies. This is intended to not only weed out the bad performers but provide ratings that can help investors track the ESG performance of the companies in their portfolio.
As an example of ESG ratings, one of the largest agencies, MSCI, looks at 37 key issues, divided into the three ESG pillars and ten themes: climate change, natural resources, pollution and waste, environmental opportunities, human capital, product liability, stakeholder opposition, social opportunities, corporate governance, and corporate behaviour. They collect data from government databases, company reports, academic research and NGO databases.
The table below lists the common ESG factors that are considered. Investments with good ESG scores have the potential to drive returns, while those with poor ESG scores may inhibit returns.
Natural resource preservation
Child and forced labour
Health and safety
Quality of management
Conflicts of interest
Transparency & disclosure
Sustainability themed funds invest in sectors where there are likely to be social and environmental benefits. These include renewable energy, clean technology, clean and affordable water, affordable housing, sustainable transport, low impact and organic agriculture, native forest conservation and planting, and green buildings.
The range of potential themes is huge. Some funds are now linking their investment outcomes to the 17 UN Sustainable Development Goals. These provide a powerful and broad framework, but credibility of themed investing also needs evidence of positive impact.
While most forms of Responsible Investment focus on avoiding damage, impact investing aims to create positive impact through funding companies or projects that have social and/or environmental benefits, as well as a financial return. Typically, investors are willing to accept a lower financial return than for investments that aim to maximise profits.
Definitions of impact investment are important. The Global Impact Investing Network (GIIN) defines impact investments as: …investments made into companies, organizations, and funds with the intention to generate measurable social and environmental impact alongside a financial return.
While it may seem that New Zealand has relatively small impact investments, such as community projects or social enterprises like Eat my Lunch, there are also a range of investments in production forestry that have the benefit of sequestering carbon, native forests that also have biodiversity benefits and affordable housing projects that provide housing for those in need.
Generally financial returns are lower for impact investing. Microfinance is one area where there has been long term data on the returns over a long period. Triodos Microfinance Fund managed by Triodos Investment Management, a subsidiary of Netherlands based Triodos Bank, reported annual returns in Euro of 7.8 to 8.7% in 2012 with returns since inception in 2009 of 4.9 – 5.4%.
The Impact Investing Network has been established to share experience and promote impact investment in New Zealand.
Active Corporate Governance
Most of the shares in companies worldwide are held by big ‘institutional investors’. These include banks, insurance companies, pension funds (such as NZ Superannuation Fund), and investment funds. They are effectively the owners of the companies, and they provide (or should provide) the corporate governance.
Most of those institutional investors track the short term earnings very closely (partly because their bonuses are often tied to increases or decreases in share prices) but ignore what impact their companies are having on the environment or societies.
However, some investment funds are active shareholders, raising issues with companies directly, joining with others in groups (such as through the UN Principles on Responsible Investment) or through taking action, such as by supporting shareholder resolutions or voting particular Directors off the Board. This is crucial in order to hold corporates to account and improve their performance.
The Responsible Investment Association of Australasia (RIAA) is a membership organisation for responsible investment in Australia and New Zealand.
Around 28% of global investment is now managed by funds that have signed up to Principles for Responsible Investment (PRI). However, most signatories still invest in companies that harm our planet and our people. Signing up to PRI is not a credible indicator of being ‘ethical’ or ‘responsible’. Sadly, there is a lot of greenwashing in the ethical and responsible investing.
Studies find wide differences in the practices of responsible investment. Until recently there have been few measurable standards, particularly for ESG management, and no verification. Research has found too many cases of unsubstantiated claims. A report Winners and Spinners found ethical funds investing in companies with poor track record of ethical practice, including Rio Tinto and Shell.
The Responsible Investment Association of Australasia (RIAA) has been one of the first organisations internationally to develop standards and processes to certify responsible investment funds. Their certification requires disclosure of all companies in the portfolio, third party assurance of internal processes and RI claims, and a ‘reasonableness test’ of the RI strategy.
As RIAA explains: “Because there are simply so many different approaches to investing (and interests that people have in it), we haven’t set out to define responsible or ethical investing or standards. Instead, we’ve served up our member’s certified products with a large dose of transparency and independent verification, so that you the consumer can draw your own conclusions from reliable information and choose investments that best suit your individual needs.”
Another form of certification is used by Mindful Money to get beyond the greenwash and provide information on credible responsible investments. There are research companies, notably MSCI and Sustainalytics, that rate individual companies according to their ESG practices. An objective measure for the responsibility of a portfolio is the aggregate of all company ESG scores in that portfolio. This is under development and will be used a part of Mindful Money’s ratings on responsible investment funds.