What does responsible investing mean to your clients?

By Diane Earnshaw, head of consulting, Square Mile Investment Consulting and Research

The asset management industry is experiencing one of the greatest shifts in investor behaviour in a generation, with investors increasingly turning their attention to how their money can be used as a force for positive change.

In 2020 alone UK savers put, on average, almost £1bn per month into responsible investment funds, according to The Investment Association.

This is by no means a new phenomenon. We have seen the industry’s response to this growing demand demonstrated in the some 500 funds and strategies launched over recent years focused using investment for good.

However, as with traditional fund management, there is no one size fits all when it comes to responsible investment and, as the market has expanded, so has the number of divergent approaches applied. Although this is ultimately a positive step forward for the industry and investors, this rapid evolution has resulted in a tricky path for advisers to navigate.

Four categories

Given the subjectivity around what constitutes responsible investment, a useful place to start is to determine what your client’s priorities are in this respect. From traditional funds, where the primary objective is to generate a financial return, to those that prioritise using investment to create a positive impact, there are four core categories of responsible investment that resonate with most investors. Although these are not mutually exclusive, recognising where your clients sit on this spectrum will help to narrow down the vast universe and identify a solution that reflects their goals.

‘Ethical exclusions’ is perhaps the most well-established category within the industry. Synonymous with the wish to avoid doing harm, funds adopting this approach will avoid investing in companies or industries which cause harm to people or the planet. The exclusion of so-called ‘sin stocks’ tends to be most commonly associated with this investment approach, for example excluding tobacco and alcohol, gambling, or the companies that produce or distribute fossil fuels.

Moving along the spectrum, funds adopting a ‘responsible practices’ approach look beyond the wish to avoid doing harm, and place an additional emphasis on doing good and leading change. The focus here is on the consideration of the operational practices of the companies in which the fund manager invests. Although they will support best practices, managers adopting this approach will also look to actively engage with investee companies to continually improve their policies and practices across a range of ESG factors. An example of this would be  encouraging a food retailer to seek to reduce the environmental impact of its supply chain and operations.

A ‘sustainable solutions’ fund seeks to invest in companies providing solutions to the world’s social and environmental challenges. These companies can vary from those supporting the transition to renewable energy to those addressing healthcare needs, and they tend to be commonly associated with areas of future structural growth. The managers adopting this type of approach will believe in the long-term financial benefits of investing this way and should be able to evidence how they are putting investors’ capital to work with respects to their sustainability criteria.

At the end of the spectrum is ‘impact investing’, whereby a fund manager will actively seek to create a positive impact for society and the environment, as well as to generate a financial return. Importantly, equal emphasis is placed on both elements within the fund’s objectives. Furthermore, managers adopting this approach will measure and report on their impact. For example, these funds may invest in companies enabling healthcare innovation and will therefore be able to report on the number of patients cared for.

As the industry continues to recognise and reflect the relationship between investment and the social and environmental challenges we face, investors will continue to be served with a greater variety of choice. Although this adds an additional element of complexity when it comes to responsible investment, establishing where your clients sit on this spectrum will allow you to sift through the noise and help find a solution that aligns to your clients’ goals and convictions.