You may have heard about socially responsible investing – or possibly sustainable investing. Whatever the name, here’s what it means in practice.
We spend a large part of our lifetime saving for retirement, with around 10 per cent of our pay packet heading straight for our superannuation fund. It’s little wonder then that we take a second glance at our super balance when the stock market takes an untimely dive.
Yet it’s not our only concern these days. In addition to wanting a healthy balance, more and more of us are hoping that our hard-earned contributions are being put to good use – to address environmental concerns and support a better society.
That’s where responsible investing comes in. Thanks to its holistic approach, many of us are well positioned to achieve both.
Investing in the best of the best
Responsible investing – also known as socially responsible, sustainable or ethical investing – takes into account a company’s financial performance as well as how it treats people, society and the environment. The underlying idea is that companies can generate a positive return for wider society as well as positive financial returns for an investor’s portfolio.
How this is achieved in practice though can differ considerably.
A case of avoidance
The foundations of responsible investment lay in faith-based organisations who in the 19th century started to simply avoid investing in certain activities e.g. the Quakers and alcohol. Nowadays, it might be that an investor will exclude specific sectors from their investment portfolio that they consider unethical or otherwise misaligned with their values. This is otherwise known as applying a negative screen.
At the same time, investors may wish to gain exposure to a specific sector if it upholds their particular values or ethics. The use of positive screens therefore ensures an investor’s portfolio has an exposure to business which is aligned to their values such as renewable energy or specific social benefits.
While this may be problematic for superannuation funds to carry out given the diversity of their members, there’s an opportunity to tilt portfolios towards certain socially accepted principles. For instance, more and more funds are looking to include environmentally friendly companies in their investment portfolios in recognition of society’s growing concern around climate change.
Incorporating ESG
A more common practice is for investors to formally incorporate consideration of Environmental, Social and Governance factors into their investment decision making.
For example, a company may be assessed on a whole swag of environmental issues, such as its carbon emissions and the degree to which it’s polluting the air or degrading the land.
Then there are the social issues to consider. Among other things, these include the company’s working conditions and how committed it is to supporting its local community and customers.
A company will also be judged on its corporate governance – essentially, how well the company is managed. This looks at factors like the diversity of the company’s board members, how much it pays its senior executives (and whether it’s justified) plus, very importantly, how transparent it is as a company.
The idea is that identifying when these factors are materially important to the business, both as a risk or an opportunity enhances the investment decision. This can both help protect against risks such as unsustainable business models and also identify opportunities to invest in companies that have great business opportunities in solving problems. Ultimately this can result in both enhanced investment returns and more holistic outcomes.
Getting active
Another approach to responsible investing is known as active ownership or stewardship. One of the key pillars of the United Nations’-backed PRI (principles of responsible investing), it focuses on investors addressing any perceived failings in how a business is managed, whether through direct engagement with its Board of Directors, proxy voting, or other external advocacy.
Direct engagement is where investors sit down with the company’s management and voice their concerns. MLC, for example, was one of a number of investors that approached Meta’s Facebook in 2021 about its newsfeed algorithm. There was concern that it was configured in a way that meant individuals were only four or five clicks away from violent content – or (in the case of Instagram) just a few clicks away from impossibly perfect lives that were detrimental to teenagers’ mental wellbeing.
As a result of investor pressure, the company put 200 programmers on to reconfigure the algorithm and now releases a quarterly incidents report that monitors how much inappropriate content is picked up and banned before it goes viral. In a clear win, the number of such incidents has jumped from 12 million to 20 million a year.
Next steps
Super funds will usually adopt a variety of approaches to responsible investing. So, if you have a lifetime of savings in super, it’s a good idea to understand the approach your particular fund takes.
Source: IOOF
