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.

Given the growth in this area, what tools do investors have to allocate towards SRI investments?

Active, passive and impact investments 

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Generally, investors have three main routes to investing sustainably – through impact investments, actively managed funds, or through index tracking investments.

The first of these lets investors have the highest direct influence with their investment by targeting individual projects or themes, and encompasses areas such as micro-finance.

Investments tend to be in private markets aimed at solving specific societal or environmental issues, or financing community projects.

Despite the clear link between these investments and the UN Sustainable Development Goals (SDGs), difficulties relating to access, liquidity and scalability of these solutions provides serious roadblocks for many investors.

Take micro credit, for example. Despite its clear impact, it is projected to represent under $18bn worldwide, which is a drop in the ocean compared with total assets in responsible strategies.

A wide range of active strategies also exist, including engagement on specific themes and the incorporation of ESG governance metrics.

However, due to the nature of active management, it can be difficult for an investor to understand the exact rules and restrictions in place.

Green bond funds, for example, are often criticised for having unclear standards – should an issuer which has poor ESG performance but is issuing a bond linked to wind farms be eligible for inclusion in what is still an SRI investment?

Finally, index-based or passive strategies provide what is often regarded as the simplest and most cost-effective way to access ESG investments for clients of all sizes.

These are generally offered in three formats: passive institutional mandates, index funds, or exchange-traded funds (ETFs).

Institutional mandates generally start from around $100m and are usually customised to suit the needs of an individual client, making them unviable for the vast majority of investors.

Index funds are easier for investors to access, but a large amount of new product development is being driven by ETF issuers, with ETFs becoming one of the most popular vehicles of access for SRI investors due to their transparency, liquidity, accessibility and low costs.

Assets in Ucits ETFs tracking SRI indices increased from $6.2bn at the start of 2017 to $14.3bn today, marking a rapid rise for ETFs as an SRI allocation tool. 

Index selection for passive investments

Once an investment wrapper has been chosen, asset managers and investors alike have the difficult job of then choosing the index they want to track, with SRI indices generally categorised into three types: negative, positive and thematic.