For many people, the value of an investment is no longer just about returns. An increasing number of investors are also demanding their money makes a positive impact on society and the world at large.

A preference for responsible investing is increasing in younger age groups in particular. Millennials, those currently aged 26 – 40 years old, value responsible or ethical investing. As this cohort moves into more senior roles, this trend is expected to accelerate.

In addition, there is an increasing focus on how companies contribute to collective public priorities such as the United Nations Sustainable Development Goals.

ESG investing

ESG is a term that has become more common in recent years, and its use has increased during the COVID-19 pandemic. ESG refers to environmental, social, and governance factors.

Fund managers are increasingly incorporating these factors into investment analysis and portfolio construction. The approach is to identify non-financial risks that may have a material effect on an asset’s value.

ESG factors include:

Environmental:

  • Climate change and carbon emissions
  • Water and waste management
  • Waste management and recycling
  • Renewable energy use
  • Pollution.

Social:

  • Commitment to diversity and gender equality
  • Human rights
  • Community relations
  • Employee engagement
  • Workplace health and safety.

Governance:

  • Board composition, diversity, and independence
  • Remuneration and incentive structures
  • Anti-bribery and corruption policy
  • Regulatory compliance
  • Shareholder and stakeholder management.

ESG factors are more difficult to measure than financial data such as earnings, and profit and loss results. A common ESG approach is to negatively screen out of the portfolio companies believed to do harm. Common exclusions include fossil-fuels, tobacco, weapons, gambling and pornography.

Other ESG approaches target companies or industries with good or improving ESG performance, or investments that specifically target sustainability themes such as clean energy or green property.

Impact investing

In impact investing, positive outcomes are the priority. Impact investors look to help a business or organisation complete a project, develop a program or produce an outcome that has a positive effect on society.

Impact funds report on financial performance, but also try to generate and quantify a positive impact such as number of schools built, number of jobs created, or reduction in carbon footprint.

Impact investments often aim to solve societal issues such as poverty or inequity. They are more likely to access opportunities via private markets than ESG funds, which typically invest in public markets.

Impact investments may target market rate financial returns or may intentionally deliver below market rate returns in order to deliver on their impact objectives.

Investing in an organisation involved in the research and development of clean energy, regardless of whether success is guaranteed, is one example. Providing affordable housing to low-income tenants at below market rental rates is another.

Impact investing is characterised by a direct connection between values-based priorities and the use of investors’ capital. Values are deeply personal, and there are increasing opportunities for investors and advisors to customise a portfolio to suit individual
priorities.

There has been a long-held view that in order to invest responsibly it’s necessary to give up financial performance. There is increasing evidence this is not the case. In its 2020 Benchmark Report, the Responsible Investment Association of Australia reported, based on Morningstar Direct research, that Australian equity and multi-sector responsible investment funds outperformed mainstream funds over one, three, five and 10-year timeframes. Global responsible funds also outperformed across all but the one-year timeframe.