Gaining a broader perspective - a guide to ESG investment approaches
Alongside traditional financial analysis, a growing number of investors are blending ESG considerations into their investment strategies. Driving this development is a desire to gain a more comprehensive understanding of the companies they invest in, identify potential risks, and uncover growth opportunities.
Indeed, global ESG-related assets under management are forecast to grow to USD33.9 trillion by 2026, compared with USD18.4 trillion in 20211. A large proportion of these assets are currently invested in Europe, but other parts of the world are catching up.
There are various terms relating to ESG investment, and such is the pace of growth that regulations, definitions, and taxonomies are still a work in progress. As a starting point, it's useful to understand some of the most common terms and how they relate to each other.
ESG investing
This is the widest – and most widely used – term, which covers the following factors:
Environmental – Conservation of the natural world
Social – Consideration of people, society, and relationships
Governance – Adherence to a set of standards for running a company
Investors and asset managers are increasingly applying these non-financial factors to their analysis of businesses to gain a fuller understanding of their operations, identify material risks and pinpoint growth opportunities. These criteria consider how well companies safeguard the environment and the communities in which they work and how management and corporate governance meet certain standards.
As a result of growing investor demand, more companies are making ESG disclosures part of their annual reports or releasing standalone sustainability documents. Various bodies, such as the International Sustainability Standards Board, the Global Reporting Initiative, and the Task Force on Climate-Related Financial Disclosures, are also working to form a set of unified standards to help incorporate these factors into the investment process.
Sustainable investing
In ‘traditional’ investment, value is created by allocating capital to investment opportunities that balance risks and expected returns. Sustainable investing combines those traditional principles with the belief that ESG factors have a long-term material impact on company performance and investor returns.
Three ideas are central to the concept of sustainable investing:
- It is additive to the asset management process.
- It develops deeper insights into how future value will be created using ESG considerations.
- It considers diverse stakeholders.
Among CFA Institute members, 85% now consider sustainability considerations when making investment decisions2.
Impact investing
Impact investing harnesses the broader goal of ESG and sustainable investment – to make a positive difference – and targets specific issues. An impact investor is looking for companies, organisations or funds that can produce a measurable social or environmental outcome and a positive financial return.
This appeals to investors who want their money to address particular areas of concern and who may place a lower priority on rates of return in exchange for a specific, measurable impact. So, an impact investment fund or company might focus on a segment such as renewable energy, clean water, affordable healthcare, sustainable food production, or education.
As such, impact investing has moved into the space once occupied almost exclusively by state donors, charities, and intergovernmental development agencies. It is increasingly popular among institutions that want to demonstrate clear corporate social responsibility results, such as banks, pension funds, wealth managers, development finance organisations, and family foundations.
Ethical investing
Ethical investing is similar to impact investing, except in this case, the investor makes decisions based on a set of values. These might be social, religious, or political.
Many different investment themes and styles fall under this banner. The approach may be "inclusive" (investing only in companies that uphold a particular set of values that have the potential to improve the planet or society, e.g., renewable energy, clean water projects or improved housing) and "exclusive" (avoiding companies in certain industries, such as tobacco or firearms, or those with a poor record on specific issues, e.g., deforestation), or a mix of both.
Ethical investors will typically demand high levels of scrutiny and disclosure to ensure their investments align with the impact they want to make.
Nature-based solutions
This investment style is based on the concept of "natural capital". The World Economic Forum estimates that over half of the world's GDP (about USD 44 trillion) has some dependence on nature3. As a result, our social and economic welfare is highly vulnerable to nature loss; however, it is alleged that humanity has done a poor job of pricing “ecosystem services” such as clean water, clean air, healthy oceans, sustainable forests, or pollination.
Nature-based investment is therefore driven by a desire to better value and manage these resources and focuses on resolving problems such as climate change, water scarcity, and ocean health.
– CFA Institute has a broad range of ESG Investing and Analysis resources that explore the concept of ESG investing, an overview of key ESG factors, and how investors can add value through ESG.
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