What is 'ethical investing'?
Growing interest in the impact of fossil fuels on the global climate is sparking questions about whether investors can integrate their values around sustainability with their financial goals and, if so, how? And sustainability preferences are not just restricted to greenhouse gas emissions - many investors also have concerns about land use and biodiversity, toxic spills and releases, operational waste, and water management, among other issues.
So just as you express your political preferences around sustainability through the ballot box, you can also make a difference through their personal participation in global capital markets.
Of course, one key question investors face is how to do this without compromising their desired investment outcomes. In other words, how can you reduce your portfolio’s environmental footprint while maintaining sound investment principles and achieving your investment objectives?
The answer, for you, may be found in 'ethical' funds. For many years, personal investors have been able to 'pivot' their individual investment strategy towards those companies that observe clearly defined behavioural guidelines in the ethical, socially responsible, and sustainable investing space.
But when we take a closer look at what is meant by responsible, ethical or sustainable investing, a whole new vocabulary comes into play. In this guide, we offer simple definitions of the more common terms you may come across when exploring responsible investing opportunities…
Responsible investing
The United Nations Principles for Responsible Investment (UNPRI) offers the following definition of Responsible Investing.
“The PRI defines responsible investment as a strategy and practice to incorporate environmental, social and governance (ESG) factors in investment decisions and active ownership.”
What this definition doesn’t explain is that a responsible investment approach acknowledges how important these ESG factors can be, both for individual investments, and for creating the stable, well-functioning and well-governed social, environmental and economic systems on which ongoing investment returns depend. Many investors now recognise that investment non-financial and financial value creation are both important, because each depends on the other.
Many people may use terms like sustainable and ethical investing instead of responsible investing and these phrases can often mean different things to different people. Responsible investment is perhaps a more universally understood term, given the UN has put forward the Principles for Responsible Investment as a global standard for incorporating ESG issues into investment practice.
United Nations Sustainable Development Goals (UNSDGS)
In addition to signing up to the UNPRI, many responsible investment products and strategies are also modelled around supporting progress with the UN Sustainable Development Goals (SDGs). They are a collection of 17 goals which set out to end poverty and injustice and protect our planet and all living things. The goals were established in 2015 and include targets to achieve by 2030.
While the SDGs provide a framework for a more just, fair and sustainable world, there is no guaranteed source of funding to support progress towards these goals. It is hoped that governments, private companies and investors will all make a contribution to reaching SDG targets through their decisions and activities. In the investment world, there already exist many opportunities to invest capital in private companies and other assets that are seen to be making a positive contribution to one or more UN SDGs. This alignment with SDGs is one of a number of responsible investment themes adopted by investment strategies. Others might be low carbon or alignment with the Paris Climate agreement or other internationally recognised standards for sustainability.
ESG
ESG is an acronym that stands for Environmental, Social and Governance. It is an umbrella term for the components of a responsible approach to investing. But as a term it is applied to a whole range of investment approaches and outcomes. So when someone describes a product as being managed or screened for ESG, this can mean many things.
The Responsible Investment Association of Australia (RIAA) provides an explainer to help you understand the different way that ESG screens, benchmarks and criteria might be used in responsible investment strategies and products.
Sustainable Finance
The goal of sustainable finance initiatives is to better align financial institutions and their activities to support better ESG outcomes. That means the activities and impacts for the whole value chain in the finance sector – lenders, borrowers, deposit holders, investors, insurers and more – need to be considered in the light of ESG criteria.
Green finance is a term sometimes used instead of sustainable finance, or to describe a sub-category that aligns specifically to better environmental outcomes.
Find out more about the Australian Sustainable Finance Initiative (ASFI)
Impact investing
Impact investing is quite different to applying ESG criteria to decide which assets to invest in. These investments are made to generate a measurable positive social and environmental impact as well as a financial return.
However, as with ESG, there are can also be many different measures of impact and types of impact. The Impact Management Project provides more information on some norms of impact management for companies and investors as well as a simplified measure of impact performance from an investor’s perspective.What is the screening process?
So who decides what's 'ethical'?
If you're considering ethical investment, look for a fund that's a member of the Responsible Investment Association Australasia (RIAA). The peak body created a certification program in partnership with the NSW Department of Environment and Conservation and the Victorian Government in 2005, with a view to making uniform standards of disclosure for funds. In order to qualify, fund managers must make a convincing case to the RIAA that they have a specific methodology in place to weed out unethical behaviour - the process is then independently verified by an accounting firm.
Where to get help?
Reach out to Westmount or a trusted Financial Planner or Advisor. We can help you sort through the myriad of ESG options out there to find the right path forward for you.
Interesting links…
United Nations Principles for Responsible Investment
Responsible Investment Association of Australia (RIAA)