Sustainable Investing Strategies
Updated: Mar 25
Investing consists in allocating capital, time, or effort, with the goal of generating value in the future. In finance, it consists in allocating capital to generate a financial return through capital appreciation or investment income. Historically, investors only considered the return and risk characteristics of investments, without considering the impact that the investment could have on the environment and society. However, more and more investors recognise the environmental and social impact of their investments and seek to combine financial and sustainability criteria into their investment process, which is referred to as sustainable and responsible investment (SRI). Indeed, SRI is a type of investment that aims to be more ethical from a sustainable development perspective, while realising a positive financial return. Thus, it implies combining financial metrics with sustainability metrics when making investment decisions. Moreover, there exist several investment strategies that incorporate sustainability into the investment process in different ways.
Exclusion is an approach that screens and excludes certain companies, sectors, or countries from the investable universe, if involved in certain activities based on specific environmental and social criteria. It is the most used SRI strategy and can be very flexible regarding its exclusion criteria. Indeed, the exclusion criteria can be based on international standards, conventions, or the investor’s values. The most common exclusion criteria include weapons, alcohol, tobacco, gambling, pornography, oil, mining, and animal testing. In the case of a country exclusion, investors may choose to avoid an entire country based on the government’s compliance with international standards. Excluding polluting companies can be achieved by screening out industries with the highest CO2 emissions. However, a shortcoming of this approach is that it does not account for companies operating in other industries, and which may have high indirect CO2 emissions.
Norms-based screening is an approach that involves the screening of companies, based on their adherence to international norms on environmental protection, human rights, labour standards, and anti-corruption. The most common norms-based screen is the UN Global Compact, which encourage companies to act in a socially responsible manner by committing to integrate and promote several principles relating to human rights, international labour standards, the environment and the fight against corruption. If a company is found to not comply with the standards, investors will assess whether exclusion is needed or not.
Sustainability-themed investing is a strategy that consists in investing in specific themes or assets linked to sustainable development. In other words, this strategy focuses on issues related to sustainability and therefore, support ecological or social change. There exist a wide variety of themes that are included in this strategy. The most common ones are water, safety, nutrition, health, forestry, education, climate change, and clean energy.
ESG integration is a strategy that explicitly adds ESG risks and opportunities into the traditional financial analysis. This approach is based on the systematic and explicit inclusion of ESG factors alongside financial factors into investment decisions. To implement this approach, it is crucial to understand how companies handle ESG risks, and whether they are well-positioned to take advantage of ESG opportunities that could offer them an edge. Moreover, a great amount of ESG data and research is necessary to successfully implement this strategy, which makes it an expensive approach.
The best-in-class strategy, also referred to as positive screening, consists in investing in the companies that have the best ESG score in a particular sector. Therefore, this strategy allows to invest in polluting industries, but only in companies which are best-in-class within these polluting industries. In other words, it promotes the best practices of companies regardless of the sector in which they operate. This strategy is often referred to as a more pragmatic approach, which enables to build a more sustainable portfolio, without compromising on diversification. Indeed, as this strategy does not exclude entire industries, it does not sacrifice portfolio diversification and allows for a broad diversification across all industries. Moreover, by picking the best companies in each industry, it benefits from sustainability in the sense of a company’s potential long-term success. However, like ESG integration, this strategy requires great amounts of ESG data which is costly. Moreover, it requires to understand which ESG factors are relevant for each industry.
Impact investing is a strategy that explicitly seeks to invest in businesses and organisations that generate a measurable positive social or environmental impact alongside a financial return. Therefore, impact investing involves the establishment of specific social and environmental priorities and objectives whose impact is measurable through an ongoing evaluation process. This differs from the other responsible investment strategies discussed above in which the social and environmental impact of the investment is usually not measured. Impact investing occurs across all asset classes and can be made both in emerging and developed markets. Moreover, it targets returns that can range from below-market to market rates, depending whether the priority of the investment is placed on positive impact or financial returns. Usually, impact investing is done via private markets and consists in investments in microfinance, community development finance, education, healthcare, infrastructure, and clean energy.
Active ownership consists in actively using one’s rights as a shareholder of a company to improve the company’s behaviour regarding ESG criteria. The two main ways to do so is by actively engaging in long-term dialogue with enterprises or by exercising voting rights at shareholder meetings. These two tools are most effective when combined and can be very effective to monitor a firm’s management. However, this approach is time consuming for investors and requires extensive knowledge about ESG issues.
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USSIF. (2021). Sustainable Investing Basics