The concept of integrating ESG (environmental, social, and governance) standards into mainstream investing is gaining tremendous traction. Investors are realizing that a company’s ESG efforts are not only important to idealistic investors, but they also represent key considerations that can have a significant impact on a company’s bottom line – both now and in the future.
Fortunately for investors, the world of ESG Investing, Sustainable Investing, Responsible Investing – all interchangeable terms that refer to incorporating ESG standards into investments – is full of choice and opportunities. However, sometimes it may be difficult to sift through the many different types of ESG funds and strategies to decide which ones best suit your values and financial targets. This article aims to provide some clarity by breaking down all the different types of funds and strategies that fall under the ESG Investing umbrella.
EXCLUSIONARY / NEGATIVE SCREENING
Negative screening or exclusionary mandates remove companies and/or sectors from a fund’s investment universe that provide certain products and/or services that have a negative impact on society (e.g., tobacco, gambling, weapons) or companies with poor ESG practices (e.g., pollution, employee safety). Exclusionary fund managers often use binary filters early in the selection process to eliminate companies from the investment universe before any financial or portfolio analysis is conducted. This type of ESG fund is best for investors that want nothing to do with certain sectors regardless of the impact that removing these names will have on their returns.
Portfolio managers enhance the portfolio construction process by integrating ESG considerations into traditional financial analysis for the purposes of managing risk and seeking opportunities. This can include top-down approaches, such as using ESG ratings, or integration into bottom-up fundamental analysis. This type of ESG fund is suited for all investors looking to invest in holistically managed funds.
BEST IN CLASS SELECTION / POSITIVE SCREENING
This process involves selecting companies that are ESG leaders within their sector. It does not necessarily exclude controversial sectors or industries, but rather invests in companies that are superior at meeting the ESG criteria that is relevant to their respective industry. Portfolio managers may take a best-in-class approach by overweighting companies with favorable ESG scores while underweighting companies with unfavorable scores. This type of ESG fund is best for investors who do not want to exclude certain industries from their portfolio but are still interested in investing in companies that are the least harmful or most beneficial to society.
Refers to the practice of corporate management, or investor engagement, which can include filing shareholder resolutions, proxy voting, and engaging in support of ESG issues. Engagement enables investors to encourage or pressure the management of the companies they invest in to take positive action, enhance disclosure on material issues, and if needed, transform the very fundamentals of their organization. Active funds do not necessarily begin as ESG friendly, but they aim to become ESG friendly overtime by driving change in their holdings. For example, an active ownership fund called VOTE won three Exxon Mobil board seats after a six-month proxy fight1. Engine No. 1, the company behind VOTE, said that Exxon needed to significantly reduce emissions and move towards a cleaner energy strategy. Engine’s new board positions would ensure this starts to happen. Although VOTE held roughly 0.02% of Exxon’s stock, the campaign was successful because it persuaded shareholders owning almost half of Exxon’s outstanding stock to join its mission. Active ownership funds are excellent for investors who want to take an activist approach to generating transformational change in public companies. Active ownership funds are best suited for patient investors who are seeking to make a long-term impact on the environment or society by supporting lobbying.
THEMATIC INVESTING / IMPACT INVESTING
Thematic investing broadly refers to funds that have an emphasis on long-term macroeconomic trends in order to capitalize on major technological, societal, and other changes expected to take place around the world. The main concept is that more capital will shift to companies and industries involved in such changes, potentially resulting in better investment performance. Thematic ESG funds – also called impact investing funds – focus on gaining exposure to a specific impact theme with the intention of generating positive and measurable social and environmental impact in addition to financial returns. Impact funds can either address ESG broadly – for example, one fund that makes investments into climate, women’s rights, and education initiatives – or they can be more specific, like funds that focus on only one facet of ESG such as the environment. Thematic or impact funds are excellent options for any kind of investor – even those who do not prioritize ESG – because they are proven to have both financial and moral benefits, as seen here: Majority of ESG funds outperform the wider market over 10 years.
GREEN BOND FUNDS
A green bond is a type of fixed-income instrument that is specifically earmarked to raise money for climate and environmental projects. These bonds are typically asset-linked and backed by the issuing entity's balance sheet, so they usually carry the same credit rating as their issuers’ other debt obligations. Green bond funds are good for investors who want to prioritize positive environmental change but also want a low-risk, low-return investment. Green bonds have the same investment thesis as traditional fixed income products and funds. They are primarily used by institutional investors such as pension funds.
As shown, integrating ESG standards into mainstream investing benefits not only society as a whole, but is also proven to have financial benefits as well. While there are plenty of opportunities to make a difference, the key is to find a strategy that best fits your values and financial targets – as well as a social issue that you find particularly important.
To learn about the Purpose Global Climate Opportunities Fund and sustainable investing, please check out these articles: The Biden Effect: How the New Administration Is Creating Waves of Climate Change, Capitalizing on Carbon Neutrality: The Past, Progress, and Potential, ESG Diaries: Defining the Value (and Limits) of ESG Integration, and ESG Diaries: Five Things We’ve Learned About Our Approach.
1. Pisani, Bob. “A new ETF is trying to make a movement out of activist investing,” CNBC, June 2021: https://www.cnbc.com/2021/06/23/a-new-etf-is-trying-to-make-a-movement-out-of-activist-investing-.html
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