Investors today are seeking value beyond straight monetary returns. With mounting evidence of climate change’s impact on the lives and livelihoods of people across the world and the growing demand for social equity, investors have gotten serious about backing corporations and funds with a demonstrated commitment to environmental and social responsibility.
A Brief History of Responsible Investing
Responsible investing has been around in one form or another for quite some time. Pacifists may choose not to invest in companies that manufacture weapons. Environmentalists may choose to invest in companies that produce durable products from natural materials.
Terms like sustainable investing, impact investing, and ethical investing were used to describe this activity. These terms, however, lacked clear definitions.
In 2006, the United Nations Principles for Responsible Investment (PRI) issued a report that suggested environmental, social, and governance data be a mandatory part of corporate financial evaluations.
The individuals behind the PRI report represented a multinational group of investment experts. Because their recommendation carried such weight, markets around the world began to adopt more clearly defined responsible investment strategies, such as ESG and SRI.
ESG vs. SRI
The two most sought-after responsible investing strategies are Environmental, Social, Governance (ESG) and Socially Responsible Investing (SRI).
While there is a lot of overlap in these two strategies, they do ultimately represent different ways to grade investment opportunities. Let’s look at what each term means and how investors use them.
What is ESG?
ESG is a business strategy (or approach) used to evaluate an organization’s financial risk, long-term sustainability, and progress-to-goal in three measurable performance areas:
- Environmental: The direct and indirect impacts an organization has on the environment and natural resources.
- Social: The impact an organization has on the direct workforce, workers in the supply chain, and communities in which it operates.
- Governance: The leadership structure of an organization and the policies and procedures in place to operate in an ethical manner including management of impacts to people and the environment.
The full scope of an ESG strategy examines not only how an organization is presently performing in these areas, but also how it plans to meet future targets for improvement and long-term resiliency.
A quarter of all sustainable investing is through ESG integrated funds, far outpacing all other sustainable investment strategies. In fact, ESG investing grew 143% between 2016 and 2020.
ESG goes beyond what standard financial assessments offer by taking a closer look at environmental, social, and governance factors. Businesses that incorporate ESG as a regular part of doing business are therefore more attractive to investors since the broader scope of data provides a more accurate reading of financial risk and opportunity.
For more on ESG, check out our ESG Ebook.
What is SRI?
Socially responsible investing is using a screening process that allows investors to independently determine investments based on ethical considerations and socially responsible behaviors.
While the criteria used to judge SRI may overlap with those measured through ESG, there are no metric-based assessments carried out. Rather, an SRI strategy takes into account ethical considerations such as:
- The charitable activity of an organization.
- Production of goods and materials that may be seen as socially harmful, such as tobacco.
- Production of weapons and firearms.
- A history of human rights violations within the organization or their supply chain.
- Corporate practices that are harmful to the environment.
The Difference Between ESG and SRI
The bottom line: ESG is an objective measure of an organization’s environmental, social, and governance behaviors, while SRI is a subjective criterion used by an investor to rate the social responsibility of an organization.
These investment strategies can be used in tandem to optimize investments in socially responsible organizations that have a greater yield potential.
ESG as a Regulatory Tool
The popularity of ESG and SRI investment funds has led several governing bodies to adopt regulations requiring ESG reporting. The United States, European Union, and several Asia-Pacific countries are leading the way in rolling out these regulations.
The EU is leading the way with both proposed and enforced ESG reporting requirements in an effort to drive industries in their region to meet 2030 and 2050 climate goals.
In the U.S., the social factors within ESG have been at the forefront of policy coming out of industry and government.
Changes coming out of the Asia-Pacific region reflect some of the urgent climate issues faced by member countries, as well as a push for more sustainable investment portfolio opportunities.
Regulations are aimed at a number of outcomes:
- Reducing corporate greenwashing and creating transparency around corporate sustainability activities.
- Increasing due diligence around human rights, environmental, and social issues across value chains.
- Increasing mandatory disclosures and create stringent definitions of sustainability activities.
- Requiring more organizations to participate in ESG disclosures.
Many of these regulations take into consideration the amount of time an initial ESG assessment can take, with some regulations offering 2-3 years to meet compliance.
Creating Value through ESG
The single most important takeaway for companies exploring ESG and socially responsible investing is the potential to create value.
By voluntarily implementing an ESG strategy, prioritizing any risks and mitigation efforts, and creating a framework for future ESG success, your organization will already have added value in the eyes of investors.
For more information on how you can get started, reach out to our ESG Due Diligence team! And for more on ESG, check out our ESG Advisory Services.
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