Responsible Investing

An Introduction to Environmental, Social, and Governance Investments

Matthew W. Sherwood, Julia Pollard

• Editore: Routledge
• Anno: 2018
• ISBN:
  9781351361910
• Edizione: 1
• Argomento: Commerce
• Categoria: Commerce Général

This textbookprovides the first holistic resource on Environmental, Social, and Governance (ESG) investing for undergraduate and graduate programs. It provides a thorough background and history of ESG investing, as well as cutting-edge industry developments, in a way that introduces the reader to the rapidly developing field of responsible investing.

Beginning with a comprehensive background of ESG investing and the development of models measuring risk and return, the book then discusses the development of ESG risks, and provides an overview of ESG rating systems. The textbook also outlines the current position of ESG investing in portfolio management through granular analysis, provides insight into common investor concerns about ESG investments, discloses qualitative theories relevant to ESG investing, and reviews literature attempting to model ESG investment performance. Finally, the authors provide readers with a foundation on the development of financial models measuring risk and return, which will be useful for measuring the performance of ESG investments. With case studies from contributors around the world, this textbook is the first of its kind to truly provide a compelling blend of quantitative and qualitative analysis supporting the incorporation of ESG investment strategies into investment portfolios.

Offering an excellent overview of the growing trends in ESG investing, as well as a close analysis of ESG theories and their practical application both today and in the future, this book will be a great resource for both undergraduates and graduate students.

Chapter 1

Introduction

Environmental, social, and governance factors are tools of great power. The measurement of these three factors provides the insight which grants quantitative authority for regulation and control by governments, corporations, investors, and consumers. This regulation and control has been shown to materially impact corporate action.

This chapter is an introduction to ESG investing terminology and to the scope of this textbook. As ESG investing is notorious for vague terminology and undefined nomenclature, this chapter brings clarity by outlining the assumptions about terminology made by the authors. Based on a wide range of sources, Environmental, Social, and Governance (ESG) investing will the overarching term under which impact investing, sustainable investing, socially responsible investing (SRI), and mission-related investing (MRI) will exist. This decision reflects current trends in vocabulary regarding this investment strategy. This chapter also discusses practical uses of the textbook, and includes brief mentions of useful features for students.

1.1 Assumptions for this textbook

Within sustainable investing there exists a few distinctions which are important to master before going further. The first distinction is between investing strategies. Investment strategies involve a set of rules, beliefs, or assumptions that govern an investor’s investment decisions. These rules, beliefs, or assumptions are based on technical and fundamental analysis of the potential investments. Within traditional investments, the reader may be familiar with investment strategies such as value investing, growth investing, and momentum trading. Within ESG investing, strategies include impact investing, ESG tilt strategies, ESG momentum strategies, green investing, and best-of-class (as well as many others that continue to develop as the concept gains traction).

Within these strategies are a variety of methodologies. These methodologies are the investor’s techniques and investing decisions made to accomplish the underlying strategy. Within traditional investing, these methodologies might include decisions based on the market capitalization, liquidity, or stock beta. Within ESG investing, these methods include ESG inclusion, ESG integration, ESG engagement, and ESG screening. Chapter 4 will provide an in-depth analysis of each of these methodologies. For now, suffice it to say that each strategy is implemented using specific methodologies. This textbook will broadly refer to all sustainable strategies as “ESG investing strategies,” and refer to each methodology by its specific strategy.

Learning objectives

• Discuss trends within ESG investing nomenclature
• Define ESG investment parameters
• Compare terminology used in Europe and North America to discuss ESG investing strategies

---

After this chapter, readers should have a basic understanding of ESG terminology, and an ability to discuss assumptions made by the authors about current trends in ESG investing nomenclature.

The role of Environmental, Social, and Governance (ESG) research-based investment strategies has been an important topic of discussion and study amongst investors for the past 30 years. To understand the different dimensions and facets of ESG investing, it is useful to first investigate the development of relevant terminology.

1.2 Terminology

One major criticism of ESG investing strategies, per academics and investors alike, is its lack of standardization of terminology and defined nomenclature. Russell Sparkes, in an article entitled “Ethical Investment: Whose Ethics, Which Investment?”, described the problem thus: “Surely here is an area characterized by at best loose terminology, at worst by a conceptual confusion that would benefit from the rigor of academic analysis” (2001). Sparkes’s criticism was in regards to the collection of vaguely defined terms surrounding socially responsible investing, which only became more extensive as the concept popularized amongst investors as the investment strategy grew. Many of the phrases critical to understanding ESG-relative investment strategy are without standardized definitions with which to identify them.

The investment industry may elect to use their own terms and phrases for their reinvestment practices. Institutional investors, asset managers, service providers, and consultants generally use the terms and definitions for ESG investing that are chosen by their governing boards, or at the request of the clients they serve. In practice, such ESG-related terminology is often interchangeable in implementation and intended meaning. Nevertheless, differences in terms, particularly in ESG approaches and methodologies, which span a broad spectrum of the field as ESG investing, are representative of a broad category with many underlying subcategories of research, risk, and financial analysis.

Many academics have attempted to identify trends in terminology that would help to define the concepts. These academics have made some progress in recent years by standardizing definitions for different relevant concepts. Below are certain definitions which have been widely accepted as accurate identifiers of certain ESG-related practices and ideas:

Impact investing: Impact investments are investments made into companies, organizations, and funds with the intention to generate social and environmental impact alongside a financial return. (Global Impact Investing Network definition).

Socially responsible investing (SRI): Sustainable, responsible, and impact investing (SRI) is an investment discipline that considers environmental, social, and corporate governance (ESG) criteria to generate long-term competitive financial returns and positive societal impact. (The Forum for Sustainable and Responsible Investment, USSIF definition).

Responsible investing (RI): Responsible investment is an approach to investing that aims to incorporate environmental, social, and governance (ESG) factors into investment decisions, to better manage risk and generate sustainable, long-term returns. (UNPRI definition).

These definitions will continue to evolve as ESG investing rapidly gains traction and study within academia. Though the terminology for socially responsible investing strategies is often vague and undefined, a widely accepted definition is:

ESG investing is the research and investment strategy framework that evaluates environmental, social, and governance factors as non-financial dimensions of a security’s valuation, performance, and risk profile.

This definition will serve as a broad scope for this book.

1.3 Useful features for students

This textbook will include several useful features for students and professors, to assist with presenting new ideas and fostering helpful discussions on the topics.

Learning objectives and discussion questions: the learning objectives, presented at the beginning of each chapter, serve to present the main ideas of a chapter in a way that prepares the reader for major takeaways and concepts to focus on. Discussion questions, presented at the end of each chapter, will correspond with the various learning objectives and will allow the reader to engage with the main concepts of the text.

Case studies: Case studies are “real-life” examples of the concepts presented in each chapter. These case studies were drafted by investment managers, policy makers, nonprofits, data service providers, independent consultants, members of the UN, and various other groups who engage daily with ESG issues. These case studies provide students with practical examples of how the topics and definitions offered in the text play out for various academics and practitioners. They offer a broad range of opinions and options for students to consider.

Learning perspectives: Learning perspectives are academic approaches to the concepts described in the text. They are more technical in nature than many of the case studies, and are designed to present a deeper dive into various topics than case studies. Learning perspectives were drafted by academics or practitioners who have spent years studying ESG investing or relevant related topics.

This textbook has been compiled first with the intent to document the history and status of ESG investment strategies in the global marketplace. To do this, this textbook discusses motivators for ESG investment strategies, potential hindrances to its growth on the global stage, and how current trends may lead to future implementation in various capacities. To that end, this textbook should be viewed as a high-level overview of the factors at place in the ESG sphere, and is most useful as an introduction for those who seek to gain a well-rounded perspective on the themes at play.

Discussion questions

1. 1) Provide a definition of ESG investing (LO1)
2. 2) Discuss the definitional differences between: impact investing, ESG integration, and exclusion (negative screening) (LO3)

---

Chapter 2

A historical survey of ESG investing

In this chapter, we will consider some of the major historical, political, social, and cultural factors which have led to the growth of ESG (Environmental, Societal, Governance) investing. Insight into the relationship between financial performance and emerging ESG strategies will be presented. Special consideration will be made of the influence that Corporate Social Responsibility (CSR) has had in the development and adoption of ESG strategies. We will view the development of ESG investing regionally and discuss modern investment practices that originated in ESG strategies, such as impact investing, micro-finance, and social venture. This chapter will specifically highlight the different types of institutions (boutique firms, large institutional investors, private investors, etc.) that have contributed to ESG investing’s growth. We note investment trends based on the investor demographics of those who have been historically attracted to ESG investing strategies and discuss the expansion of ESG investing in a variety of investment sectors and asset classes. In summary, this chapter should provide a helpful summary of the environment in which ESG investment trends developed – a historical foundation upon which the rest of this book depends, and a tool through which readers can use historical trends to predict the future of ESG Investing.

Learning objectives

• Name and discuss historical, political, social, and cultural events contributing to the growth of ESG investment strategies
• Examine major causal factors which have and will affect the development of ESG investing
• Identify facets of the relationship between financial performance and ESG investment strategies
• Distinguish between the varying levels of ESG investment integration in different markets such as the United States, Europe, Asia, and emerging markets
• Use financial tools to analyze potential future trends in ESG investing

---

2.1 Progression of investing theories: neo-classical economics encounters human nature

Historically, economists and investors alike operated on the notion that investment behavior need be influenced by only two factors: financial return and risk. This notion emerged from the neo-classical economics school of thought, which holds three main tenants:

1. 1 Individuals have rational preferences regarding purposes
2. 2 Individuals maximize utility and firms maximize profits
3. 3 Individuals act independently based on complete and relevant information (Roy Weintraub, 2002; Marinescu, 2016)

Understanding the “Homo oeconomicus” (the “economic man”) is key to unlocking neo-classical economics. The term refers to the economic individual characterized by the following traits: rational, self-interested, insatiable, and utilitarian.

The perception of mankind’s prevailing self-interest has not changed since Adam Smith published The Wealth of Nations in 1776. In “Homo Oeconomicus and Behavioral Economics,” Justyna Brzezicka and Radoslaw Wisniewski described “The classical homo oeconomicus” as “like a cyborg calculating costs and profits: he lacks passion, does not give into temptations, and is not greedy nor altruistic.”

In his study “The Rational Choice Generalization of Neoclassical Economics Reconsidered: Any Theoretical Legitimation for Economic Imperialism?”, Milan Zafirovski described homo oeconomicus as:

Atomistic individuals free from complex interdependencies, the pursuit of pure self-interest (construed as happiness), farsighted rationality and accurate cost-benefit calculation, market equilibrium and/or (the Pareto) optimum, parametric individual preferences/values, technologies, social institutions and cultures, consistent maximization of profit (producers) and utility (consumers), free and perfect competition, a laissez-faire government, full knowledge and complete information.

Theories such as the rational choice theory were based on the idea that in the same situation, every individual would make the same decision to maximize his own self-interest (Marinescu, 2016). However, this homo oeconomicus was a dissatisfying model for many who argued the advantage of incorporating psychology within economic analysis. Behavioral economic theory began to gain a foothold in the early to mid-1900s, supported by those who were unable to reconcile the cold and calculating homo oeconomicus with the behaviors and tendencies of their own ...