Understand common strategies within the responsible investing and sustainability space and how they could impact your portfolio.
Words matter when it comes to this space. At RBC Wealth Management, we use the umbrella term “responsible investing” to describe how you can use environmental, social and governance (ESG) data—or extra financial factors—that can be analyzed to make more informed investment decisions.
With a warming climate among the world’s leading concerns, governments and corporations are making commitments to their communities to shoulder the responsibility of tackling this crisis.
Many individuals also want to help slow down the disastrous effects of climate change and are turning to their investments as a way of supporting companies that place adequate emphasis on sustainable operations and responsible business models.
As this global push toward long-term sustainability grows, it’s vital to comprehend the various investment approaches—and the different commitments they call for—to better assess which approach fits your financial goals.
Understanding the definitions and concepts of terms in the responsible investing and sustainability field may aid the decision-making process in verifying a firm’s climate commitments and help you build your investment strategy.
At the end of 2023, the CFA Institute, the Global Sustainable Investment Alliance and Principles for Responsible Investment issued guidance for harmonized definitions for responsible investment approaches. In an effort to address greenwashing, it aims to bring greater understanding and consistency to terminology used in responsible investing, specifically: screening, ESG integration, thematic investing, stewardship and impact investing. This resource aligns with how RBC Wealth Management approaches responsible investing.
How it affects decisions: Responsible investment is about incorporating ESG data into a portfolio through various strategies. At RBC, we focus on the four main applications to incorporate responsible investing into a client’s portfolio: ESG integration, ESG screening and exclusion, thematic ESG investing and impact investing. These applications are not mutually exclusive, and they provide investors with additional choices on how to create their portfolio to help achieve their financial goals. A portfolio or product can incorporate more than one strategy.
This is the practice of incorporating material ESG 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. ESG factors can be material to different types of companies. Some of these factors include:
How it affects decisions: “ESG integration is a risk-management framework that looks at ESG factors at the same time as traditional financial analysis—think enhanced fundamental analysis,” says Kent McClanahan, head of Responsible Investing at RBC Wealth Management–U.S. Incorporating more data into an investment portfolio through ESG integration helps create a clearer picture to better understand the potential impacts to long-term value.
Applying positive or negative screens to include or exclude assets from the investment universe. Investors can use this application to align their portfolio with certain values or themes.
How it affects decisions: This is about values alignment and may include investing in line with certain principles, norms or religious beliefs. Screening identifies assets that meet a desired set of ESG-related criteria, often based on a percentage of revenue or product involvement.
When applying a screen or exclusion, a threshold is incorporated that can narrow the investable universe, potentially causing unintended consequences that may impact an investment portfolio.
Investing in assets involved in a particular ESG-related theme (e.g. water, clean energy, agriculture, sustainability) or seeking to address a specific social or environmental issue. This is where the theme of sustainability fits.
How it affects decisions: With thematic investing, there is an intentional allocation of capital to a specific investment theme. For example, funding in sustainable technology (SusTech) companies, which help mitigate sustainability challenges through technology and have the potential to create long-term opportunities for companies and shareholders alike.
It emphasizes the long-term use of natural and socioeconomic resources without depleting their availability for the future.
How it affects decisions: “As more people realize that immediate changes are needed to mitigate the impact of a warming climate, investment parameters have expanded from purely financial returns to encompass positive environmental and societal impact,” McClanahan says.
It involves investing in companies and projects that intentionally seek to generate a measurable positive social or environmental impact alongside traditional financial risk and return.
How it affects decisions: “Impact investing has a philanthropic element,” McClanahan says. “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.
This is the total amount of greenhouse gas generated by the actions of individuals or organizations. Greenhouse gases can be emitted through means such as energy use, paper consumption, travel, the production and consumption of food and waste generation. As greenhouse gas emissions blanket the Earth, they trap the sun’s heat, which results in global warming and climate change. Warmer temperatures over time lead to changing weather patterns, disrupting the balance of nature.
How it affects decisions: It’s important to consider what average emissions are at a sector level. According to Climate Watch, the energy sector accounts for 75 percent of total greenhouse gas emissions globally, while other top contributors include sectors in agriculture, industrial processes and waste. A portfolio seeking to minimize carbon emissions will likely be concentrated in a few select sectors that produce lower emissions.
Net zero means cutting greenhouse gas (GHG) emissions to as close to zero as possible, with any remaining emissions reabsorbed from the atmosphere by oceans and forests, for instance. It is about achieving a balance between the GHG emissions produced by human activity and those removed from the atmosphere.
The journey to net-zero emissions must be orderly and inclusive and balance society’s current energy needs with a vision of a more sustainable future. Investing in the transition to net zero means supporting companies that have ambitious carbon reduction goals and are compensating for remaining emissions that cannot be mitigated using carbon removal technologies.
This is the act of conveying an inaccurate impression or misleading information that makes 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,” McClanahan explains. Analyze the language and look for declarative statements such as “We are” and “We will.”
McClanahan says the lack of industry standardization for terminology can create confusion, so the best way to determine the appropriate strategy is to review your financial objectives.
“The first thing to ask is, ‘Do you want to incorporate additional data and choice into your portfolio?’” he explains. “Some may prioritize the environment over social impact, while others may not focus on impact but seek to invest in an ESG-integrated 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.”
Strategies can also be combined. For example, a portfolio could apply both ESG integration and a thematic focus, such as reducing emissions.
“Advisors take an ESG-integrated approach by identifying companies that are considered ‘improvers’—those that may not be great now but are rapidly improving and investing in new technologies for a more sustainable future and business,” McClanahan says.
As this space continues to evolve, reach out to your advisor for more on responsible investing.
Due diligence processes do not assure a profit or protect against loss. Like any type of investing, responsible investing involves risk, including possible loss of principal. Past performance does not guarantee future results.
Investment and insurance products offered through RBC Wealth Management are not insured by the FDIC or any other federal government agency, are not deposits or other obligations of, or guaranteed by, a bank or any bank affiliate, and are subject to investment risks, including possible loss of the principal amount invested.
RBC Wealth Management, a division of RBC Capital Markets, LLC, registered investment adviser and Member NYSE/FINRA/SIPC.