Introduction to ESG Investing Flashcards
ESG Investing
An approach to managing assets where investors explicitly incorporate environmental, social, & governance (ESG) factors in their investment decisions with the long-term return of an investment portfolio in mind.
Responsible Investment
A strategy & practice to incorporate ESG factors into investment decisions & active ownership.
At a minimum, responsible investment consists of mitigating risky ESG practices in order to protect value.
To this end, it considers both how ESG might influence the risk-adjusted return of an asset & the stability of an economy and how investment in & engagement with assets & investees can impact society & the environment.
Socially Responsible Investment
Approaches that apply social & environmental criteria in evaluating companies.
Investors implementing SRI generally score companies using a chosen set of criteria, usually in conjuction with sector-specific weightings.
The first screen to create a list of SRI-qualified companies is called a hurdle.
Sustainable Investment
The selection of assets that contribute in some way to a sustainable economy - that is, an asset that minimizes natural & social depletion.
It can also be used to mean a strategy that screens out activities considered contrary to long-term environmental & social sustainability, such as coal mining or exporing for oil in the Arctic regions.
Best-In-Class Investment
a.k.a “Positive Screening”
An investment that involves selecting only the companies that overcome a defined ranking hurdle, established using ESG criteria within each sector or industry.
- Firms are scored on a variety of factors that are wieghted according to the sector.
- The portfolio is then assembled from the list of qualified firms.
Note: Not all best-in-class funds are considered “responsible investments.”
Ethical/Values-Driven & Faith-Based Investment
Investing in line with certain principles, often using negative screening to avoid investing in companies whose products and services are deemed morally objectionable by the investor or certain religions, international declarations, conventions, or voluntary agreements.
Faith-based investors have a history of shareholder activism to improve the conduct of investee companies.
A popular strategy: Portfolio building with a focus on screening out the negative. This is essentially avoiding assets that are at odds with their beliefs.
Thematic Investment
Investment in themes or assets specifically related to ESG factors:
* Clean Energy
* Green Technology
* Sustainable Agriculture
* Gender Diversity
* Affordable Housing
Two common themes:
1. Increasing Demand for Energy & Water
2. The Availability of Alternative Sources of Energy & Water
Keep in mind:
Not all thematic funds are considered to be responsible investments or best-in-class. Becoming such a fund also depends on the ESG characteristics of the investee companies.
Green Investment
Green investment refers to allocating capital to assest that mitigate:
* climate change
* biodiversity loss
* resource inefficiency,
* other enviornmental challenges.
These can include:
* low-carbon power generation & vehicles,
* smart grids,
* energy efficiency,
* pollution control,
* recycling,
* waste management & waste of energy, and
* other technologies & processes that contribute to solving paticular environmental problems.
Green invesmtent can thus be considered a broad subcategory of thematic investment and/or impact investing.
Social Investment
Allocating capital to assets that address social challenges. These can be products that address the bottom of the pyramid (BOP) which referes to the poorest two-thirds of the economic human pyramid, a group of more than 4 billion people living in poverty.
Broadly, BOP refers to a market-based model of economic development that seeks to simultaneously alleviate poverty while providing growth and profits for businesses serving these communities.
Examples include:
* micro-finance & micro-insurance
* access to basic telecommunication
* access to improved nutrition & health care, and
* access to (clean) energy
Impact Investing
Investments made with the specific intent of generating positive, measurable social or environmental impact alongside a financial return (which differentiates it from philanthropy).
Impact investments are usually associated with direct investments, such as private debt, private equity, and real estate.
* In more recent years, it has increasingly become more mainstream in the public markets.
Impact investments provide capital to address the world’s most pressing challenges:
* UN SDG 6: Clean Water and Sanitation - Ensure availability and sustainable management of water & sanitation for all.
* UN SDG 11: Sustainable Cities & Communities - Make cities and human settlements inclusive, safe, resilient, & sustainable.
CFA Institute Global ESG Disclosure Standards for Investment Products
The 1st global voluntary standards for disclosing how an investment product considers ESG issues in its objectives, investment process, & stewardship activities.
What is the concept of ESG Investing closely related to?
The concept of ESG Investing is closely related to the concept of investees’ corporate sustainability. Related to this, corporate social responsibility (CSR) is a broad business concept that describes a company’s commitment to conducting business in an ethical way.
Which forms of responsible investment is ultimately related to portfolio construction?
All forms of responsible investment except for engagement are ultimately related to portfolio construction (in other words, which securities a fund holds).
Some focus more on improving financial returns using financially material ESG factors, while other combine robust returns with optimizing the impact the investment has on society and the environment.
Engagement, both by equity owners and bold holders, concerns whether and how a fund tries to encourage and influence an issuer’s behavior on ESG matters.
Name one of the main reasons for ESG integration and list what can cause financial materiality.
One of the main reasons for ESG intergration is that responsible investment can reduce risk and enhance returns.
Financial materiality can be due to:
* reduced cost and increased efficiency
* reduced risk of fines
* reduced externalities, and
* improved adaptability to sustainability megatrends.
