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Investment Institute

What does responsible investment mean in practice?

  • 09 June 2021 (5 min read)

Responsible investing (RI) refers to strategies and practices that incorporate environmental, social and governance (ESG) factors in investment decisions and active ownership.

Responsible investing equals better investing

RI increasingly also encompasses Corporate Social Responsibility, which describes activities undertaken by companies which reflect their responsibilities to the public and not just shareholders. RI enables clients to align their investments with the major trends that are changing the investment landscape such as increasing regulation, the growing need for risk mitigation and a heightened social conscience.

RI has benefitted from increased momentum over the past 18 months, with the idea rapidly moving up the agenda of investors. As the global economy recovers to its pre-pandemic level, we believe the focus on this form of investing will intensify, particularly with COP 26, the United Nations Climate Change Conference, being held in Glasgow later this year.

The growing momentum behind RI

It is worth remembering how dramatically things have changed in favour of RI over the past year or so, particularly with regards to totemic issues such as climate change. 68% of global GDP is now covered by net zero commitments to CO2 emissions by 2050, for example, compared to less than half of global GDP twelve months ago. As governments recognise the risks from global warming and come under pressure from voters, they are signalling a shift towards a cleaner economy, creating opportunities for businesses with clean technologies who have effectively seen a dramatic expansion in their addressable markets over the past year.

Greater awareness around RI feeds through into many areas, including what clients demand of us and other asset managers. Investors are appreciating that they can take action on climate change, and that this even represents an attractive source of returns.

While client demand is driving investment managers towards sustainable offerings, we see this across the wider economy too – such as with electric vehicles. Car manufacturers and their suppliers are also recognising that other sustainability issues need to be addressed, such as the water intensity of lithium production or the dependence of batteries on rare earth materials, which may be able to be designed down or even out of battery systems.

Companies not directly involved in sustainable solutions are also acting, understanding that their brands may be damaged if they are not seen as acting sustainably. Facebook, for example, has a commitment to net zero emissions, particularly significant given its dependence on energy intensive data centres. By recognising that they need to be seen as sustainable, companies are creating increased demand for the providers of renewable energy and other solutions.

What are the investment opportunities?

We believe RI offers investors a number of opportunities, whether through directly investing in the shares of companies delivering solutions to challenges such as climate change, or by buying bonds which finance specific projects (often referred to as green bonds or, more widely, Green, Social and Sustainability Bonds, or GSSBs).

The green bond market has grown significantly over the past five years and has become far more established. It has even overtaken more mature markets such as European high yield bonds in terms of size. In fact, the green bond market today is a credible alternative to global aggregate bonds. It has approximately the same duration profile and arguably a better balance between sovereign and corporate issuers. Green bonds could now act as a core fixed income allocation for investors and are able to act as a traditional fixed income hedge to equities.

On the equity side, the universe is much bigger than commonly perceived and is wider than the traditional wind or solar farm manufacturers and operators, important as those are. As renewables contribute more to electricity grids, for example, the market for companies involved in smart grids or battery storage solutions becomes greater. An underappreciated point is that as GDP becomes more electric dependent (i.e. as we electrify transport and industrial processes), we will need to think about how the demand pattern changes. The shift to a low carbon economy involves reimaging almost the entirety of our economy and how it has been built up over the past 150 years.

What does the future hold?

The momentum behind RI will undoubtedly continue to build, helping to contribute to a more sustainable planet. We expect greater standardisation of ESG reporting in the short to medium term, as asset managers put pressure on data providers to deliver a consistent set of metrics to allow efficient comparison between company scores or even investment portfolios. Asset and wealth managers will themselves be responding to increased client and regulatory demand for ESG reporting, not least with the implementation of the EU’s Sustainable Finance Disclosures.

Over the longer term, more funding is needed for the technologies which will help us reduce emissions through the 2030s and beyond. According to the International Energy Agency, much of the technology needed to reduce emissions in the 2020s is already profitable; it just needs investment to be rolled out. Beyond this decade, however, we will be reliant on solutions yet to become economical or even to be invented. While this may seem daunting, we believe it highlights the long-term nature of Responsible Investing, and the exciting pipeline of opportunities which will come through in the next few decades.

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