Profit with principles

Rob Morgan looks at how socially responsible investing can help change the world for the better as well as make money for investors.

| 6 min read

Socially responsible investing (SRI) is all about wanting your investments to do more than make money. It shouldn’t be confused with ‘ethical’ investing – strictly speaking that means excluding companies or areas that are believed to be morally wrong such as tobacco, alcohol and weapons. SRI is a broader term and covers a range of approaches including sustainable, ethical, responsible, green, and impact investing.

This array of ‘labels’ isn’t necessarily helpful to the ordinary investor. Despite the financial industry aiming to coalesce around definitions for key terms, they are often incorrectly used or conflated. But the bottom line is that choosing investments that help address environmental and social issues is a simple yet powerful way to make a positive impact on the world.

The more people invest this way the greater the impact companies will feel on their ‘cost of capital’ – their ability to raise equity or borrow money – so the SRI movement has a real-world impact. This is why even business that don’t really consider these issues important are having to take their environmental and social responsibilities increasingly seriously. The more investors care about them the more they will have to too.

What is ESG?

There’s a common framework for investing in a socially responsible manner: Environmental, social and governance (or ESG) factors, are non-financial considerations that inform investment decisions. The aim is to examine a company in a more 3-dimensional way rather than focusing on single issues and come to an overall conclusion.

A thorough ESG analysis also serves to highlight key risks so it’s useful to all investors, even those who don’t have any non-financial goals. Businesses that don’t address key environmental and social concerns or pay attention to governance issues could be deemed unsustainable in the long run and are more likely to suffer negative publicity or even a customer backlash.

While all investors can benefit from the principles behind ESG analysis lots of issues are subjective and many are hard to measure precisely. ESG ‘scores’ represent the sum of a myriad of factors affecting the potential of an investment and the non-financial risks surrounding it. However, there is increasingly an expectation that all these issues must be taken account of in any diligent analysis.

A trend, some would say a ‘movement’

While traditional ethical funds simply excluded a range of companies – or whole industries – deemed unethical, many of today’s approaches are more holistic with increasing focus on more positive factors and an alignment of portfolios with targets, for instance in respect to climate change, recycling, or social improvement. These investors will invest in companies they believe contribute meaningfully (and ideally measurably) to a more sustainable world. Others prioritise ‘engagement’, aiming to engender change across companies through dialogue and voting on key issues.

While various forms of SRI are employed, there is no doubt that the overall movement has become increasingly popular in recent years. Our own research has found that almost half of UK investors (48%) expect to increase their environmental, social and governance (ESG) investments over the next three years, with one in six (17%) planning to do so significantly. During the pandemic there is evidence to suggest this popularity has grown even more.

The ‘Covid effect’

For all investors Covid-19 has been a reminder that financial markets don’t exist in isolation, they are part of the fabric of society. Companies’ success depends on their ability to navigate the challenges and trends around them, and on occasions, this results in unforeseen events that test their resilience. Among the sustainability issues that have been brought into sharper focus are the viability of long and complex supply chains and whether large offices and mass commuting is strictly necessary in a digital age.

As well as acting appropriately to protect their own interests, there has been a greater focus on companies’ treatment of other stakeholders besides shareholders – for instance employees, customers and suppliers. Covid-19 has helped accelerate the trend of broader social and environmental issues moving up the corporate agenda. Companies are being more widely scrutinised for their impact on society, not just their earnings potential and balance sheets. The concepts of corporate ‘responsibility’ and ‘sustainability’ have become more embedded.

The virus has also focussed the minds of politicians on the concept of ‘building back better’, and in particular the move to green energy. To aid the recovery, subsidies, taxes and regulations will direct investors to commit much more to green outcomes.

The future of Responsible Investing

Most businesses are now aware there is increasing emphasis on transparency and high standards that go beyond the traditional financial variables that investors have historically focussed on. Ultimately, this affects the extent to which they can attract capital and the rates at which they can borrow, so they have a vested interest in improving. The more people that invest responsibly the greater pressure there is on companies to improve, helping drive the pace of change. We expect this form of investing to have a considerable influence on companies’ actions and on financial returns going forward.

Taking ESG factors into account is likely to be increasingly seen as the ‘standard’ approach. As a result, in the future socially responsible investing won’t necessarily be seen as a different ‘channel’, all investors will be taking ESG factors into consideration to some extent and investor preferences will increasingly be factored in. Some form of standardisation and labelling for funds is also anticipated, which should make it easier for investors to choose individual investments that meet their requirements.

Investment ideas

It’s often assumed that socially responsible investing (SRI) means sacrificing performance, but our analysis found that these investments cement longer term outperformance .Our Collectives Research Team has identified some high-quality funds that not only meet our criteria in terms of their investment credentials but genuinely embrace the principles of a certain branch of SRI. You can find them in the dedicated section of our Direct Investment Service Preferred List if you are looking for ideas. Please note any fund should be carefully considered to see if it fits individual principles as well as investment objectives.

You can find out more about how you can become a responsible investor, including definitions of the key terms, on the dedicated section of our website.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Profit with principles

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