Demystifying Responsible Investing: what you need to know
“Sustainable”. “Green”. “Ethical”. “Responsible”.
Although described in many different ways, investing in funds or companies that reflect your beliefs and values has been one of the fastest-growing investment trends in recent years. In Canada, about $3.2 trillion in assets are under some sort of a responsible investment strategy – a 49% increase from two years prior. Around the world, investors expect to increase the share of sustainably invested assets from 18% to 37% by 2025. And at Educators Financial Group, our clients are also interested in RI – in our recent Responsible Investing Survey, over 80% of respondents considered that RI was important.
If you’re one of the many investors interested in this type of investing, it’s a good idea to understand the most commonly used terms, and the differences between them.
What is Responsible Investment?
Responsible Investment (RI), sometimes referred to as “Sustainable Investment”, is an umbrella term encompassing a broad range of approaches that incorporates environmental, social and governance considerations in the investment process.
Generally speaking, RI includes three investment strategies:
- ESG Integration
- Socially Responsible Investing (SRI)
- Impact Investing
“Because they feature an increased focus on the same values, RI’s three main strategies may seem similar on the surface. But there are differences in their objectives and means,” says Nanaki Vij, Advisory Support Associate, Educators Financial Group. The primary goal in ESG Integration is financial performance, while Impact Investing is meant to make a quantifiable impact on a societal goal. Socially Responsible Investing is somewhere in the middle.
The chart below gives an overview of different strategies’ objectives and means, compared to those of a typical fund.
|TYPICAL FUND||ESG INTEGRATION||SOCIALLY RESPONSIBLE INVESTING||IMPACT INVESTING|
|OBJECTIVE||Financial return||Financial return with improved process by integrating ESG criteria in selecting securities||Financial return while including or avoiding certain companies or sectors||Financial return and specific social purpose|
|MEANS||Traditional manager||More robust risk assessment and use of some ESG filters||Constrains on the type of investment||Considers companies or funds with a specific goal|
What is ESG Integration?
Objective: to generate financial returns while using a decision-making process that includes ESG criteria. ESG Integration looks at how a company’s policies and practices will impact future returns. Certain companies or sectors are commonly filtered out (such as weapons, alcohol, tobacco and gambling).
ESG is the most commonly used RI term, and is sometimes used as a default term for Socially Responsible Investing and Impact Investing. The acronym stands for:
- Environment – concerns such as lowering carbon emissions, investing in green energy production, or greening certain industries
- Social – considerations like gender equality, supply chain treatment, or strong labour practices
- Governance – considers how well a company is run and managed; avoiding companies that may be corrupt, poorly run or have a poor reputation
Nanaki says investors should be aware there is an element of subjectivity in judging whether an investment follows ESG requirements. “ESG investment choices are based on data provided by rating agencies, which grade companies on a wide range of ESG factors. The metrics that agencies choose to use are subjective, though, and industry analysts agree there is a need for standardized reporting.”
What is Socially Responsible Investing?
Objective: to generate financial returns while including or avoiding certain companies or sectors.
SRI is sometimes referred to as “conscious” or “ethical” investing. With SRI, positive and/or negative screening is applied. This involves filtering out specific companies, sectors, and even countries based on ethical or moral beliefs and specifically including those that show leadership in environmental and social issues. For example, companies involved in the extraction and processing of coal, oil or natural gas may be filtered out and companies with exemplary employee relations practices may be included.
Another strategy that can be guided by SRI strategies is Thematic Investing, which has the aim of investing in companies whose activity covers one or two areas of sustainable development. Thematic investing allows investors to express a view that may cut across market capitalization, sector classification, and region.
What is Impact Investing?
Objective: making a measurable social or environmental impact.
“One example of Impact Investing would be investing in companies that are working on innovative solutions to clean-water access or the clean-energy transition,” says Nanaki.
Impact investments are characterized by three terms:
- Intentionality: investors have identified a cause
- Additionality: the addition of the funds from the investor is necessary for the impact to be achieved, and
- Impact measurement: elements of measurement5.
The bulk of impact investing is done by institutional investors, including hedge funds, private foundations, banks, pension funds, and other fund managers. However, some socially conscious financial service companies, web-based investment platforms, and investor networks now offer individuals an opportunity to participate, too.
Does Responsible Investing mean lower returns?
For a long time, opponents of RI argued that it must result in lower returns, mainly because there were fewer companies to invest in. Advocates, on the other hand, argued that companies that adhered to unsustainable activities would underperform competitors, and that, while RI had fewer choices, those choices were more attractive.
However, more recent empirical studies conclude that RI does not equate to lower returns and may even enhance performance. This was particularly seen during the 2020 global pandemic in which 83% of RI funds in Canada outperformed their average asset class in the one-year period ending March 31, 2020. Furthermore, RI can offer protection against downside risk1.
How do you decide what kind of Responsible Investment is right for you?
Now when you’re aware of the key difference between these approaches, it’s time to decide what works best for you.
You can start by asking yourself these questions:
- Which of my values is a priority and should be reflected in my portfolio?
- What aspect of sustainable investment (Environmental, Social, or Governance) am I focused on?
- Do I seek more returns, want to mitigate risks, or make an impact?
- Am I informed?
What Responsible Investment options are offered by Educators?
Educators Financial Group offers RI options in the Canadian and Global Equities space, as well as Canadian Fixed Income category. Beyond our Responsible Investment offering, all of our fund managers follow an ESG Integration approach and adhere to the six Principles of Responsible Investment (PRIs) established by the United Nations. We also monitor for such things as performance and value to ensure our clients are getting a diverse portfolio of quality investment options that meet their specific financial objectives.
You can count on Educators Financial Group for the investment advice you need to bring your financial dreams to life. We’ve been exclusively serving the financial needs and goals of education members since 1975—let us put all of that experience to work for you.
1 Canadian Securities Institute, Responsible Investing Course (2021)