Demographic shifts and a growing desire to have a positive impact in the community will likely drive a surge in interest for responsible investing.
Responsible investing (RI) has been around in one form or another for more than three decades. But interest has boomed in recent years, particularly with individual investors. Climate change, corruption, cybersecurity and a lack of gender diversity in companies are some of the concerns prompting many people to think about changing the way they invest.
Responsible investment assets have skyrocketed in recent years as companies continue to innovate and strive for positive impacts.
“People are starting to care more about what a company does, and not just what its earnings are,” says Kent McClanahan, vice president of responsible investing at RBC Wealth Management–U.S.
That sentiment, coupled with the data-backed realization that companies that pay attention to factors beyond their bottom line perform better in the long run, is pushing responsible investing to the top of many investors’ minds, he says.
RI is an umbrella term encompassing several different approaches used to deliberately incorporate environmental, social and governance (ESG) considerations into an investment portfolio. These approaches are not mutually exclusive; multiple strategies can be applied simultaneously within the investment process. There are four main approaches to this data:
ESG integration involves systematically incorporating material ESG factors into investment decision-making to identify potential risks and opportunities and improve long-term, risk-adjusted return. This is when investors consider more than traditional financial measures, such as the intangibles of a company’s ESG practices.
“This approach considers risks that traditional finance might ignore,” McClanahan says. “Increasingly, these risks have outsized impacts on the value of investments. Investors who are not considering these factors may see increased volatility within their portfolios.”
ESG integration happens at the same time as traditional financial analysis, and focuses on the material extra-financial, or ESG, factors that are important to the future earnings of a company. E, S and G factors are examined in tandem with fundamental factors to define attractive investments with long-term returns in focus.
“ESG integration goes beyond earnings, debt, ratios, and other items found on the financial statements,” McClanahan says. “It’s the information about how a firm operates its business, inputs used to make a product, how a firm treats its employees, and the way a company is managed. Material ESG factors could come to bear on the financials of a company.”
A few examples of ESG factors include:
This approach involves applying positive or negative screening of companies, industries, or sectors to either include or exclude assets from a portfolio. This is often referred to as investing in line with one’s values, or values alignment. Screening and exclusions are accomplished by including or withdrawing support from investments to make a financial influence that aligns with predefined values, or identifying assets that meet a defined set of desired ESG-criteria or ESG score threshold.
“More and more, investors are looking to make a positive change by aligning their personal values with their investment choices,” McClanahan says.
ESG exclusions and screening can include positive/negative screening, socially responsible investing (SRI), inclusions/exclusions, and more.
This strategy focuses on investing in assets involved in a particular sustainability or ESG-related theme, or seeking to address a specific social or environmental issue. Examples of themes may include: water, climate, renewable energy, social housing, human rights and education. With thematic investing, there may be a focus on directing capital across a range of themes and/or targeting the United Nations Sustainable Development Goals demonstrating measurable real world impact.
“Sustainability has become a key concern for companies and investors alike, as both can benefit if growth and profits are sustainable,” McClanahan says. “Innovation and technology will play a critical role in creating solutions to make a more sustainable global economy.”
A number of technologies have emerged to help create a more sustainable planet, with more on the horizon. These are referred to as “SusTech,” or Sustainability through Technology. Several specific SusTech themes will likely play an increasingly important role in the economy, including:
Finally, impact investing focuses on companies and projects that proactively seek to generate a measurable positive social or environmental impact—alongside a financial return. These investments are seeking to fund change. Impact investing is not charity, and investors still want a return on their investment, but they may be willing to take a capital loss as long as there are tangible, measurable results for the investment.
“Every company has a social or environmental impact, whether positive or negative,” says McClanahan. “Impact investments attempt to measure this impact and see that they’re having a positive influence on society or the environment.”
For example, an investor seeking returns could invest their capital in a project that assists underserved communities through support for low- and moderate-income home buyers, affordable rental housing units, small business administration loans and economic development.
Research indicates that interest in responsible investing continues to grow. A 2021 survey of high-earning and high-net-worth millennials conducted by RBC Wealth Management–U.S. found that 85 percent of respondents said it’s important to align their investments with their values, such as ESG principles, and that these types of investments are an integral part of their investment strategy.
Millennials’ incomes are rising, and they are set to be on the receiving end of one of the largest wealth transfers in history—approximately $80 trillion is expected to pass from boomers to the next generation, according to a report by Cerulli Associates. As they begin to invest that wealth, millennials might continue to fuel the growth of RI.
Women are also rising in influence. According to the National Association of Women Business Owners, women now control 52 pecent of wealth, which is expected to grow to an estimated two-thirds by 2030. Women are adding to their assets at a rate of $5 trillion per year globally, according to research by the Boston Consulting Group. How they choose to invest that wealth will have a significant impact, McClanahan says.
“The convergence of these demographic shifts and a growing desire among these influential groups of investors to have a positive impact in their community and broader society is likely the beginning of what will be a surge in interest in responsible investing,” says McClanahan.
Due diligence processes do not assure a profit or protect against loss. Like any type of investing, ESG and responsible investing involve risks, including possible loss of principal.
RBC Wealth Management, a division of RBC Capital Markets, LLC, registered investment adviser and Member NYSE/FINRA/SIPC.
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