Understanding passive approaches to SRI

  • Learn about the history of ESG investments and SRI, as well as the differences between the two.
  • Consider the three main routes to investing sustainably including passive, active and impact investments.
  • Understand the index selection for passive investments and what is behind investor selection.
Understanding passive approaches to SRI

Socially responsible investing (SRI) and environmental, social and governance (ESG) issues are among the hottest topics in the investment management industry today, and are likely to remain at the forefront for investment professionals for the foreseeable future. 

According to the 2016 Global Sustainable Investment Review, almost $23trn of assets are managed under responsible investment strategies, up 25 per cent since 2014.

More than 2,000 organisations, including asset owners, investment managers and service providers, have become signatories to the United Nations (UN) Principles for Responsible Investment, marking an almost 10-fold increase over the past decade.

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These organisations represent over $70trn in assets under management, demonstrating a strong commitment across the industry. 

To understand this market it is first necessary to recognise that the two terms, SRI and ESG, are often used interchangeably, although a clear distinction can be made between them.

SRI is generally seen as more of a broad term used to cover investments that integrate or incorporate any ESG issues into investment processes.

ESG investments, however, tend to refer to the explicit consideration of environmental, social and governance issues into investment analysis and portfolio construction, with the view that ESG and corporate financial performance (CFP) of companies are interlinked. 

The rapid transition of SRI from the fringe to the mainstream has largely been driven by three factors.

First, awareness of the financial benefits of SRI has followed the same path as academic research, increasing significantly over the last 40 years.

Around 2,250 unique studies focusing on the correlation between ESG investing and CFP have been published over this period (70 per cent of them in the past 15 years).

A study conducted by DWS in conjunction with the University of Hamburg reviewed the entirety of this research. They found that between 48 per cent and 63 per cent of studies showed a positive correlation between ESG and CFP, and only 10 per cent displayed a negative correlation, further supporting the notion that ESG metrics help investors identify risks and opportunities in their portfolio, with high ESG-rated companies exhibiting lower tail risks and lower costs of capital.

Second, increased asset owner engagement on the topic and increased demand for SRI solutions has inevitably led to an increase in assets.

Assets linked to ESG corporate engagement grew by 42 per cent between 2014 and 2016, with asset owners and investment managers increasingly employing strategies to impact corporate strategy through lobbying senior management on ESG issues, or voting in line with ESG guidelines.

Asset owners are also demanding more from their investment managers in the form of reporting, with the 2017 Independent Research in Responsible Investment Survey finding that 82 per cent of asset owners require managers to report on ESG activity and corporate governance. 

Finally, the rising tide of regulation is leaving asset managers with little choice but to take notice.

Ranging from corporate disclosure to responsible ownership initiatives, and requirements for integrating and incorporating sustainable investing into their investment process, regulation is increasing exponentially.