Sustainable investing has a long history. Today it is embraced by some of the world’s largest institutional investors who are committed to socially responsible and fossil fuel free investing.
The evolution of the sustainable investing movement dates to the 18th Century. The Quakers and Methodists advocated certain standards of behaviour and treatment, including the abolition of slavery, fair employment conditions and avoiding alcohol and gambling. This informed their investment values.
In the 1960s, the Vietnam War prompted thousands of people in the US to boycott companies that produced weapons used in the war. Meanwhile, the civil rights movement prompted people to voice concerns about investing in companies not recognising human rights.
Following soon after, in 1971 Pax World created what it claims was the first socially responsible investment (SRI) fund in America.
In the 1980s, environmental concerns gained more attention as global warming became a greater focus and disasters such as Bhopal and Exxon Valdez forced people to realise just how much harm corporations could do to communities and the environment if they did not act responsibly.
Thousands of people in the Indian city of Bhopal died in 1984 from poisonous gases leaked from a nearby Union Carbide plant. The Exxon Valdez oil spill in Alaska in 1989 was, at the time, the worst human-caused environmental disaster in history.
These lessons weren’t heeded by BP which was responsible for the deadly Deepwater Horizon oil rig disaster in 2010. BP was ruled to be “grossly negligent” and was forced to sell assets to cover its costs which exceeded US$61 billion.
Then even before the clean-up was complete two other global corporate giants Vale and BHP Billiton were embroiled in yet another environmental and community disaster with the collapse of the Fundao dam in Brazil in November, 2015 flooding towns and the environment with toxic sludge from mining operations nearby.
And we have barely scratched the surface. Corporate governance failures and frauds, supply chain labour standard injustices, lack of women and broader diversity on boards and excessive remuneration are just a sample of many other issues that are increasingly driving shareholder activism.
By far the most prominent issue being that of climate change due to greenhouse gas emissions which led to the Paris Climate Agreement to which 175 countries are party and committed to responding to the global climate change threat by keeping a global temperature rise this century below two degrees Celsius above pre-industrial levels.
It is no surprise that consideration of these kinds of risks associated with a company’s business activities has now become part of both the quantitative and the qualitative investment processes of professional fund managers.
Reflecting this, the United Nations launched the Principles for Responsible Investment (PRI) initiative.
The Principles were developed by investors, for investors, to contribute to developing a more sustainable global financial system. The PRI now has more than 1,800 signatories, including VanEck, from over 50 countries, representing approximately US$70 trillion.
Defining socially responsible investing
SRI generally involves ‘negative screens’ to exclude investments in companies involved in such business activities as gambling or pornography or the production of tobacco, alcohol, military weapons and civilian firearms.
There are many portfolios that exclude companies because of such anti-social or irresponsible activities.
Incorporating environmental, social, and governance (ESG)
Another form of sustainable investing considers ESG factors in investment decision-making. These may be applied by both negative and positive screens and usually involve a rating system.
ESG factors include such considerations as labour standards, greenhouse gas (CO2) emissions, workplace diversity, efficient use of resources and corporate governance practices.
ESG analysis can not only help investors align their investments with their values by negative screening, it can also help investors avoid controversies such as the Volkswagen emissions scandal by positive screens for ESG leaders.
Avoiding Volkswagen in portfolios not only had a social impact, but also protected people’s investments when Volkswagen’s share price crashed.
Potential to boost investment returns
The global momentum around sustainable investment is now building as retail and institutional investors demand companies behave in a socially responsible way.
There is also recognition in the financial community that portfolios may benefit from responsible investing.
Analysis from MSCI, the world’s leading ESG index provider, indicates that ESG can have a positive impact on performance.
In their paper, Can ESG Add Alpha, MSCI analysed the performance of two portfolios, one with an ‘ESG Tilt’ strategy overweight stocks with higher ESG ratings. The second was an ‘ESG Momentum’ strategy overweight stocks that have improved their ESG rating over recent time periods.
“We find that both of these strategies outperformed the global benchmark over the last eight years, while also improving the ESG profile of the portfolios. Furthermore, a significant part of their outperformance was not explained by style factors, and thus may have been attributable to ESG factors,” MSCI said.
According to the Responsible Investment Benchmark Report 2017, “the comparison of responsible investment funds against mainstream equivalent funds and their benchmark index indicates outperformance across the majority of time periods”.
Investment products evolve
Many active fund managers incorporate ESG factors into their risk analysis.
However, few fund managers combine ESG leaders, SRI, and the exclusion of fossil fuels and ‘carbon criminals’ into one portfolio. Many investment products offer only one or two of these strategies.
Until now. VanEck has recently partnered with MSCI to create a state-of-the-art sustainability index which incorporates both values-based and impact investing.
The MSCI World ex Australia ex Fossil Fuel Select SRI and Low Carbon Capped Index (ESGI Index) is an in-depth sustainability index.
The selection process for the ESGI Index involves very high sustainability standards.
Companies are identified from the MSCI World ex Australia Index by a multi-screen approach as follows:
- excluding companies with fossil fuel reserves for energy purposes;
- excluding companies whose businesses are involved in non-SRI activities such as alcohol, gambling, tobacco, military weapons, civilian firearms, nuclear power, adult entertainment and genetically modified organisms;
- including only the leading ESG performers in each sector; and
- excluding high carbon emitters.
The result is a comprehensive, in depth sustainability index in MSCI’s ESG family. The VanEck Vectors MSCI International Sustainable Equity ETF (ASX: ESGI) tracks the ESGI Index.
Now, investors can more easily align their investments to their values through this portfolio of around 200 international ESG leaders in a single trade on ASX.
Russell Grigg is general counsel and head of compliance, Asia Pacific at VanEck.
