Today, more and more investors have greater expectations from the companies they invest in. It’s about more than companies turning a profit – it’s about how they do it. Are they protecting or harming the environment? Are they respecting or disregarding human rights? Investors want to know that companies are good corporate citizens.
Investment management firms have reacted to investors’ expectations, and the responsible investing movement is flourishing. There are several different types of responsible investing. Socially responsible investing, for example, typically involves including or excluding investments according to ethical guidelines. Impact investing helps companies and organizations develop specific social or environmental projects that benefit society. But the most common approach in Canada is environmental, social and governance (ESG) investing.
ESG investing typically integrates environmental, social and governance factors into the traditional process of research, analysis and investment selection. The environmental screen looks for any practices or acts of negligence that harm the environment, including high carbon emissions, toxic chemical exposure and lack of habitat protection. The social category is all about respecting employees and suppliers, including issues such as labour rights, safety in the workplace and gender pay equity. Governance involves the responsibility of a corporation’s leadership, including the independence of its board members, implementation of anti-corruption measures and managing of consumer relations.
Say, for example, that an environmental concern emerges when it’s discovered that a manufacturing company has repeatedly paid fines for improperly storing and disposing of hazardous waste. Perhaps a social issue requires investigation if news circulates that a clothing company has outsourced production work overseas involving meagre pay and unsatisfactory working conditions. Or say a governance matter arises because the board of an energy firm may not have taken proper measures to prevent against cyber attacks. Any issues like these must be taken into consideration as potential investment risks.
In addition to integrating ESG factors into investment selection, investment management firms monitor the ESG practices of companies they invest in and take action if improvements are called for. That’s essential to ESG investing – holding companies accountable for the way they respect the environment, society and their shareholders.
Taking action often begins with seeking disclosure of specific ESG matters. When issues are evident, firms should communicate with management, using their influence as investors to affect change. They can also take advantage of shareholder voting rights when corporate decisions involve ESG measures.
Benefits of ESG investing
ESG investing gives investors the satisfaction of knowing they’re helping to promote respect and care for the environment and society. It’s also important to know that you don’t have to compromise on performance. Numerous studies in Canada, the U.S. and internationally show that, overall, traditional investments and ESG investments have similar returns. In fact, according to the Responsible Investment Association, most Canadian responsible investing funds outperformed their average asset class returns over the 10-year period ending June 30, 2021.1
Also, ESG investing has the potential to offer downside protection and reduce portfolio risk. That’s largely due to the extra layer of screening to identify environmental, social and governance risks in the investment selection process. Companies that experience ESG controversies can see their share prices suffer.
If you would like more information about responsible investing in general or how it relates to your portfolio, please get in touch.