With climate change among the world's leading concerns, governments and corporations are building commitments to their communities and to responsibly steward natural resources.
Many individuals also have a desire to support the environment and are turning to their investments as a way of supporting companies that place adequate emphasis on sustainable operations and business models.
As this global push toward sustainability grows, it's vital to understand the various investment approaches, and the different commitments they call for, to better assess which approach fits your values.
Understanding the definitions and concepts of terms in the sustainability field may aid the decision-making process in verifying a firm's climate commitments and help you build a climate-friendly strategy.
What is sustainability?
Sustainability is an umbrella term that emphasizes on responsible use of natural and socioeconomic resources without depleting their availability for the future.
How it affects decisions: As more people realize positive environmental change is key to the future, investment parameters have expanded from purely financial returns to encompass positive environmental and societal impact, says Jasmine Duan, investment strategist at RBC Wealth Management in Asia. For example, funding in sustainable technology (SusTech) companies, which help mitigate sustainability challenges through technology, has surged in recent years.
What is a carbon footprint?
A carbon footprint is the total amount of greenhouse gas generated by the actions of individuals or organizations. Greenhouse gases can be emitted through things such as energy use, paper consumption, travel, the production and consumption of food and waste generation.
How it affects decisions: It's important to consider what average emissions are at a sector level. A portfolio seeking to minimise carbon emissions will likely be concentrated in a few select sectors that produce lower emissions.
What are net-zero emissions?
Net-zero emissions refers to achieving a balance between the greenhouse gases going into the atmosphere and those being removed from the atmosphere.
How it affects decisions: Achieving net-zero emissions calls for stricter requirements than being carbon neutral, another common term.
“Many companies are aiming for net-zero, but there's still a long way to go," says Duan. Net-zero firms must eliminate emissions without relying on offsetting whereas carbon neutral firms can still emit carbon dioxide and offset it by purchasing carbon credits.
“Claims that a certain portfolio is net-zero should be reviewed closely," adds Stephen Metcalf, head of Sustainable Investing for RBC Wealth Management in the British Isles and Asia. For example, such a portfolio might closely follow the Paris Agreement and commit to seven percent year-on-year greenhouse gas emissions reductions. Verify claims against sustainability benchmarks, such as environmental, social and governance (ESG) scores or science-based targets.
What is climate positive?
Climate positive (interchangeable with "carbon negative") is when an organization's activities create an environmental benefit by removing additional greenhouse gases.
How it affects decisions: A company that commits to becoming climate positive goes beyond striking a balance between the emissions being created and removed (net-zero). Industries with complex supply chains, such as manufacturing and retail, may take longer to be climate positive.
What is ESG integration?
ESG integration is the practice of considering environmental, social and governance factors as part of the investment decision-making process to identify and assess potential risks and opportunities that can impact long-term, risk-adjusted returns.
How it affects decisions: "ESG integration is not a strategy but a risk-management framework that includes ESG factors in financial analysis," says Metcalf. Strategies include responsible investing, sustainable investing and impact investing, all of which may also help to identify potential risks and opportunities in addition to traditional financial analysis.
ESG factor examples
What is responsible investing?
Responsible investing, similar to sustainable investing, looks to create or withdraw support for companies and sectors based on their alignment with an investor's personal values.
How it affects decisions: Responsible investing is focused on avoiding harm and contributing to solutions. It involves negative and positive screening: the former involves excluding investments in harmful businesses, such as alcohol, tobacco and weapons, to minimize ESG risk, while the latter sees portfolios tilted toward organizations in areas such as renewable energy, social housing and human rights.
Metcalf identifies a similar approach, socially responsible investing (SRI), as a higher form of responsible investing with stricter criteria.
What is impact investing?
Impact investing involves investing in companies and projects that intentionally seek to generate a measurable positive social or environmental impact rather than profits alone.
How it affects decisions: Impact investing has a philanthropic element, says Metcalf. “You should be able to say, 'By investing, I have caused something to happen that wouldn't otherwise have occurred.'" This is challenging to achieve in public markets. Therefore the bulk of impact investing tends to happen through private equity, venture capital or funding startups.
What is greenwashing?
Greenwashing is the act of conveying an inaccurate impression or misleading information making it seem like an organization's actions or investments are more beneficial on environmental factors than they really are.
How it affects decisions: You may detect greenwashing by reading a company's annual report to determine if it has transparent disclosure on climate goals and progress, and how it's integrating climate risks and opportunities into its corporate strategy, Duan says. Analyse the language and look for declarative statements such as “we are" and “we will."
Determining which strategy fits best
Both Duan and Metcalf say the lack of industry standardization of sustainability terms can create confusion, so the best way to determine the appropriate strategy is to know your values.
“The first thing to ask is, 'What problems do you want to address in society?'" says Duan.
“Some may prioritize the environment over social impact," adds Metcalf. “Others may not focus on impact but seek to invest in an ESG portfolio for the risk-adjusted returns. Matching those risk and value preferences to solutions is important. It's definitely something to address with your advisor."
Sustainability strategies can also be combined. For example, a portfolio could apply both negative screening and an ESG score to filter companies.
Wealth managers with the capability to make sustainability determinations – such as managers with backgrounds in climate science – also may create a diversified portfolio that isn't overexposed on a particular sector.
For example, some managers may identify companies that “aren't great now but are improving rapidly," Metcalf says. “As there is no single way of assessing what is credible, rely on someone to do that in a consistent way."
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