Ethical/SRI 

Why clients are interested in values-based investing

  • Understand what the different definitions of values-based investing are and how each approach works.
  • Consider the size of the values-based investing sector and the effect on performance.
  • Learn the challenges faced by the industry.
CPD
Approx.30min
Why clients are interested in values-based investing

For some investors, maximising their returns or beating a benchmark is not the only thing that’s important.

These investors, instead, attempt to create portfolios that reflect their values and beliefs.

As well as looking at the investment’s expected return, volatility and correlation with other asset classes, they will also look at the company’s corporate practices and policies to make sure they are in line with the investor’s principles.

This approach generally comes under the following categories:

  • Negative/exclusionary screening, often known as ethical;
  • Environmental, social and governance (ESG) factor investing;
  • Impact investing.

Each is now considered in a bit more detail.

Negative/exclusionary screening is the original form of values-based investing and it aligns investments with beliefs by screening out companies, or even industries, based on specific criteria.

Examples of such criteria include a significant portion of the firm’s profit coming from alcohol, gambling, tobacco or weapons; or the company using animal testing or child labour. This is still the most widely used values-based approach globally.

ESG factor investing is newer and it involves searching out and including companies based on desired environmental, social and governance characteristics rather than excluding firms with undesirable business activities.

Some might argue that this is not new, as factors such as reputational risk and regulatory developments have always been part of traditional fundamental analysis and risk assessment.

The ESG factor approach, however, involves a more systematic consideration of specified ESG issues throughout the entire investment process.

Below are some examples of ESG factors:

  • Environmental - climate change/carbon emissions and toxic emissions/waste;
  • Social - health and safety of employees, data protection/privacy and community relations;
  • Governance - diversity, compensation and business ethics.

Some ESG managers go beyond integrating their defined factors into their security selection process and actively support their principles through shareholder engagement.

Such fund managers will, for example, communicate directly with the company’s senior management to improve ESG practices or exercise their voting rights.

While many investors and managers use ESG factors for values alignment, others will include ESG in their investment process for risk management and as a source of potentially superior financial returns. In the case of negative/exclusionary screening, however, returns will always be secondary to the investor’s values.

Although ESG investing is not as large as exclusionary screening, it is growing more quickly.

Impact investing refers to investing for both a financial and social benefit.

The objective is to create a positive and measurable impact in solving environmental or social issues in addition to achieving a financial return.

Examples include clean technology, developing sources of renewable energy or backing entrepreneurs collaborating with community organisations.

Most impact investments, as they tend to require substantial capital, are private investments. This is the smallest but fastest growing area of values-based investing.

The table below shows Investment Association (IA) numbers for ethical funds under management (1) in £m and (2) as a percentage of total industry funds under management for UK investors investing in both UK domiciled and overseas domiciled funds:

Source: Investment Association

Although ethical funds under management have increased over the past 10 or so years, their share as a percentage of the industry total has remained broadly constant over this time.

CPD
Approx.30min

Please answer the six multiple choice questions below in order to bank your CPD. Multiple attempts are available until all questions are correctly answered.

  1. There are three main types of values-based investing, according to the author. Which one of these is the odd one out?

  2. Is the following statement true or false? The ESG factor approach, however, involves a less systematic consideration of specified ESG issues throughout the entire investment process.

  3. The objective of impact investing is to create a what type of impact in solving environmental or social issues?

  4. Complete the following sentence: Although ethical funds under management have increased over the past 10 or so years, their share as a percentage of the industry total has remained what?

  5. In the first part of the Arabesque Partners and Oxford University report, what percentage of reviewed sources show that companies with strong ESG practices demonstrate better operational performance and are less risky?

  6. Values-based investing has seen what over the past few years, according to the author?

Nearly There…

You have successfully answered all the questions correctly, well done!

You should now know…

  • Understand what the different definitions of values-based investing are and how each approach works.
  • Consider the size of the values-based investing sector and the effect on performance.
  • Learn the challenges faced by the industry.

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