Introduction to ESG Investing Flashcards
define ESG investment
Responsible investment
how ESG issues can impact the long-term return
no universal standard for which factors are included under the “E,” “S,” & “G” definitions, may overlap — animals & animal well-being may be considered in both environmental & social factors. How these factors are split depends on who are defining them (for example, for an ESG framework) & stakeholders
What is Short-termism
trading practices, where investors trade based on anticipation of short-term price movements rather than long-term value
investors prioritizes maximizing near-term financial results, over long-term value creation.
Negative impacts of short-termism
offer rewards but may have adverse long-term consequences
promote bubbles, financial instability & general economic underperformance
ignore factors that are considered long term, such as ESG
What is Shareholder Rights Directive (SRD)?
counter short-termism — issued by EU in 2020, requiring investors to be active owners and to act with a more long-term focus.
Define Environmental Factors
Pertain to the natural world — include the use of & interaction w/ renewable & non-renewable resources (e.g., water, minerals, ecosystems, and biodiversity).
Define Social Factors
Affect the lives of humans— includes the management of human capital, non-human animals, local communities & clients.
Define Governance Factors
Involve issues tied to countries and/or jurisdictions or are common practice in an industry + interests of broader stakeholder groups.
Define Governance Factors
Involve issues tied to countries and/or jurisdictions or are common practice in an industry + interests of broader stakeholder groups.
What is Responsible investment?
incorporate ESG factors into investment decisions & active ownership
consists of mitigating risky ESG practices to protect value
encompasses how ESG factors might influence the risk-adjusted return of an asset
considers the stability of an economy & how investment in & engagement w/ assets & investees can impact society & environment.
What are the different types of Responsible Investment?
Socially Responsible Investment
Best-in-Class Investment
Sustainable Investment
Thematic Investment
Green Investment
Social Investment
Impact Investment
Ethical/Values-Driven & Faith-Based Investment — Christian & Shari’a
Shareholder Engagement
Corporate Social Responsibility
Can an investment portfolio comprise of more than 1 approach of Responsible Investment?
Yes, approaches are not mutually exclusive
What is Socially Responsible Investment?
approaches that apply social & environmental criteria in evaluating companies using a set of criteria with sector-specific weightings. A hurdle is established for qualification within the investment universe, based either on the full universe or sector by sector. This information serves as a first screen to create a list of SRI-qualified companies.
What can SRI ranking be used with?
best-in-class investment, thematic funds, high-conviction funds, or quantitative investment strategies
What is Best-in-Class Investment aka positive screening?
selecting only the companies that overcome a defined ranking hurdle, established using ESG criteria within each sector/industry.
companies are scored on a variety of factors that are weighted according to the sector. The portfolio is then assembled from the list of qualified companies.
not all best-in-class funds are considered “responsible investments.”
best-in-class investment is commonly used in?
Due to its all-sector approach, it is used in investment strategies that try to maintain similar profile/select similar security of a benchmark/target index
Eg: MSCI World SRI Index, which is designed to represent the performance of companies with high ESG ratings and uses a best-in-class selection approach to target the top 25% companies in each sector, has characteristics similar but not identical to those of the MSCI World Index.
What is Sustainable investment?
- Pick assets that contribute to a sustainable economy/minimizes natural and social resource depletion.
- broad term, used for the consideration of typical ESG issues.
- may include best-in-class and/or ESG integration, which considers how ESG issues impact a security’s risk and return profile.
- describe the prioritization of the selection of companies with positive impact or companies that will benefit from sustainable macro-trends.
- screens out activities considered contrary to long-term environmental & social sustainability, eg mining/burning coal/exploring for oil
What is Thematic Investment?
based on needs arising from environmental/social challenges
What are the 2 common thematic investments?
- access to low-carbon energy — Global economic development raised the energy demand + increase GHG emissions, negatively affect climate.
- access to & efficient use of water — rising living standards & industrial needs created greater water & electricity demand + the need to prevent drought/increase access to clean drinking
Are all thematic funds considered responsible investments or best-in-class?
No, it depends on the theme of the fund & ESG characteristics of the investee companies
What is Green investment?
broad subcategory of thematic/impact investing
refers to allocating capital to assets that mitigate environmental challenges:
1. climate change
2. biodiversity loss
3. resource inefficiency
Includes
1. low-carbon power generation and vehicles
2. smart grids
3. energy efficiency
4. pollution control
5. recycling
6. waste management & waste of energy,
7. other technologies/processes that contribute to solving environmental problems
What are Green bonds?
Considered as Green investment, a fixed-income instrument thats used to raise money for climate & environmental projects
What is Social investment?
allocating capital to assets that address social challenges, eg products that address the bottom of the pyramid (BOP), poorest two-thirds of the economic human pyramid. It’s also a market-based model of economic development that seeks to simultaneously alleviate poverty while providing growth and profits for businesses serving these communities, eg:
► micro-finance & micro-insurance,
► access to basic telecommunication,
► access to improved nutrition & health care
► access to (clean) energy.
Can Social investing include social impact bonds?
Yes, social impact bonds are a mechanism to contract with the public sector. This sector pays for better social outcomes in certain services & passes on part of the savings achieved to investors.
What is Impact investing?
investments made with the specific intent of generating positive, measurable social/environmental impact with a financial return (which differentiates it from philanthropy).
provide capital to address the world’s most pressing challenges, eg investing in products/services that help achieve any of the 17 Sustainable Development Goals (SDGs) launched by the United Nations
associated with direct investments, eg private debt, private equity & real estate.
Can impact investments be made in both emerging and developed markets?
Yes
What’s the difference between impact investing & philanthropy?
Impact investing: social + financial return expectations
philanthropy: social return expectations only
What is Ethical and faith-based investment?
investing in line with certain principles — use negative screening to avoid investing in companies whose products & services are deemed morally objectionable by the investor or religions, international declarations, conventions, or voluntary agreements, commonly:
► tobacco,
► alcohol,
► pornography,
► weapons
► significant breach of agreements, such as the Universal Declaration of Human Rights or the International Labour Organization’s Declaration on Fundamental Principles and Rights at Work.
What are some examples of faith-based negative screening?
a. Investments consistent with Christian values, avoid firms that
1. facilitate abortion/contraceptives/embryonic stem-cell research
2. involved in weapons production & sale
favor firms that support human rights, environmental responsibility & fair employment practices via labor unions.
b. Shari’a: honour Islamic religious principles, avoid
1. firms that profit from alcohol/pornography/gambling;
2. companies that pay interest;
3. investments that pay interest;
4. liaisons with firms that earn a big part of revenue from interest
5. investment in pork-related biz
What is Shareholder engagement and what does its efficacy depends on?
reflects active ownership by investors — try to influence a biz decisions on ESG matters
efficacy usually depends on
1. scale of ownership
2. quality of the engagement & method used
3. whether the company has been informed by the investor that divestment is a possible sanction.
What is Corporate Social Responsibility?
company’s commitment to conducting its biz in an ethical way — create long-term stakeholder value
What are the benefits of CSR?
- reaffirm the company’s license to operate in the eyes of gov/society
- increase efficiency
- attend to increasing regulatory requirements
- reduce the chances of fines
- improve employee satisfaction/productivity
- drive innovation/new product lines.
Pros/cons of incorporating ESG in decision making
- negative megatrends will create a drag on economic prosperity as basic inputs (eg water, energy, land) become scarce & expensive + health & income inequalities increase instability — affect asset owners, who depend on market returns to pay out pensions & settle liabilities.
- High levels of income inequality can create social stresses — conflict/violence
challenges of incorporating ESG in decision making
- Fiduciary duty: need to deliver financial returns to their beneficiaries hence cannot do more in terms of ESG since it’s misconstrued as not financially material
What are the values in being able to spot winners and losers in a rapidly changing risk landscape?
operate with a longer time frame, with the objective of understanding emerging risks, convert these into above-market performance.
Examples of climate-driven hazards on biz.
risks in manufacturing due to water depletion aggravated by climate change — higher costs + suffering from more extreme weather events.
How does ESG issues cause assets to be stranded?
assets can become obsolete due to regulatory, environmental, or market constraints. Eg, social conflict related to disruptions to water supplies has resulted in the suspension of US$21.5b in mining projects
What are investors modern fiduciary duties?
► Incorporate financially material ESG factors into investment decision
► incorporate sustainability preferences into investment decisions, regardless of whether it’s financially material.
► Be active owners, encouraging high ESG standards performance in companies
► Support the stability & resilience of the financial system.
► Disclose investment approach clearly
r/s between ESG investment & financial system stability
climate change as a potential systemic risk
What does focusing on investments with a positive impact and/or avoiding those with a negative impact means?
Positive impact: put beneficiaries’ money to good use rather than to invest it in any activity that could be construed as doing harm
negative impact: aka negative screening, don’t invest in controversial sectors (eg: arms, gambling, alcohol, tobacco, and pornography) + environmental factors (eg: fossil fuel companies) + governance factors (eg: avoid companies that are in breach of certain business practices)
What is Glasgow Financial Alliance for Net Zero?
Asset owners committing to transition their investment portfolios to net-zero GHG emissions by 2050.
What are hard & soft laws?
Hard laws: actual binding legal instruments and laws.
Soft laws: quasi-legal instruments — not legally binding/weaker binding force + can become hard law
(Quasi-legal: not strictly legal, but are enforced by an entity with some legal authority)
What is Shareholder Rights Directive (SRD)?
issued by the European Union (EU) in 2020, requiring investors to be active owners and to act with a more long-term focus.
Can ESG integration reduce risk/enhance returns?
Yess because it considers additional risks and injects new & forward-looking insights into the investment process.
ESG integration can lead to what benefits?
- reduced cost and increased efficiency
- reduced risk of fines and state intervention
- reduced negative externalities
- improved ability to benefit from sustainability megatrends.
Large institutional investors have holdings that, due to their size, are highly diversi- fied across all asset classes, sectors, and regions. As a result, the portfolios of universal owners, as they are known, are sufficiently representative of global capital markets that they effectively hold a slice of the overall market.
