The recent federal election highlighted interest in climate change, as well as the potential impacts on communities and the population, with the issue No. 1 or 2 in priority for most voters.
Climate change is one of a broader set of environmental, social and governance issues percolating through the investment world right now. ESG, or sustainable investing, is the more evolved version of socially responsible investing, which was prevalent in the 1990s.
SRI was about exclusion and traced its roots in Quaker and Methodist religious theory. John Wesley, one of the founders of Methodism, in his sermon “The Use of Money” outlined his basic tenets of social investing; namely, don’t harm a neighbour through business practices. This meant avoiding industries like tanning and chemical production, both prevalent at the time, which could harm the health of workers.
Read: Back to basics on responsible investing
Over the years, this morphed into avoiding “sinful” companies that sell products related to guns, liquor and tobacco. In some cases, it also included companies engaged in mining, oil extraction and lumber. In the 1990s, products abounded, with new indices developed to help investors avoid non-SRI compliant companies.
While some organizations (usually endowments, foundations, religious orders and charities) still maintain exclusionary policies, the approach was problematic for pension funds, whose obligation was to ensure benefits are paid as they come due and without taking undue risk. Furthermore, there could be performance discrepancies for plan sponsors investing through a broad index versus those employing adjusted SRI indices.
In the early days, it was difficult to determine how much of a large conglomerate’s revenue was generated from those items to exclude versus products or services that would be considered benign. As an example, General Electric Co. makes both lighting, a benign example, and nuclear reactors, which is problematic for some investors.
Read: ESG and impact investing beyond screens
In the past decade or so, SRI has been superseded by sustainable investing, which is about inclusion and change rather than exclusion. Sustainable investing embraces investment strategies that seek to consider both financial returns and social/environmental good to bring about social change. It has its roots in the union movement, which embraced jobs, affordable housing and safe work practices, and 1960s activism that focused on gender and race equality.
Sustainable investing has expanded to include better governance of environmental factors, such as climate change, consumer protection, human rights and gender diversity, for example.
But many might still ask, “Why should I care?” Well, for a number of reasons. In Ontario, pension plan sponsors are required to include a statement about whether ESG factors are incorporated in their investment policies and, if so, how. Furthermore, there’s an increasing fiduciary obligation to do so, recognized by the United Nations. In its 2015 paper, “Fiduciary Duty in the 21st Century,” the UN Principles for Responsible Investment stated, “failing to consider all long-term investment value drivers, including ESG issues, is a failure of fiduciary duty.”
Within their organizations, many plan sponsors may have corporate social responsibility or sustainable investment policies that should be aligned with pension investment practices. They should also consider current and future employees and stakeholders, including millennials and generation Z, who are quite interested in social issues and how these impact the workplace, business and investment decisions. The link between ESG issues and financial performance is equally compelling.
Read: Two-thirds of institutional investors use ESG analysis
While investors have typically focused on risk avoidance in the past, the realization that sustainable investment can also include the exploitation of themes is growing. For a long time, investors have known companies with a poor record of corporate governance won’t be likely to see their share price rewarded — over the long term. Companies that aren’t good corporate citizens have also seen an impact on their share prices. While it’s important to avoid companies that engage in these behaviours, it’s equally important to ensure investment managers are thinking about how to exploit sustainability.
Renewable power is an example of the latter, given the stated mandate of many governments to reduce carbon output. Investment in solar, wind, bio-fuel and geothermal power generation and distribution companies and assets isn’t only good for the environment, it’s increasingly profitable. The improvement in batteries is making renewable power more cost-effective for users as well.
Another environmental-related theme is electric cars, or the increased use of ride sharing services by younger generations. In such an environment, car parks may not be a good long-term investment, for example.
While there’s a lot to consider, most plan sponsors are barely scratching the surface when considering what sustainable investment may mean for their investment portfolios. It’s an important and evolving dialogue for everyone. And it’s not only important to explore how an organization will engage in this area, it’s necessary.