By Amy Domini, Founder and Chair of Domini Impact Investments
Impact investing is everywhere these days. It’s in the news. It’s on people’s minds. And it’s part of an increasing number of investment portfolios. Investors are embracing the idea that if we are to live on a green planet that allows every human to thrive, they must play an active role.
As a result, we are witnessing a meteoric rise in Environmental, Social, and Governance (ESG) research for investment decision-making. Dedicated sustainable investing is set to soar to $13 trillion in assets under management by 2025 and analysts are predicting 2022 will be the year that provision of environmental and social considerations of investors becomes a mainstream market driver. Reflecting a booming sector, 67% of financial advisory companies are already planning to buy more shares in ESG-researched products.
These statistics demonstrate that investors care—a lot. Current events are contributing to ethical investors’ commitment to what I call “investing for good.” Extreme weather incidents and international agreements arising from COP26 have continued to propel climate change to the forefront of investing decisions. Meanwhile, the recent pandemic and the death of George Floyd have seen social and governance issues rise to parity with environmental considerations among conscientious investors.
Because know that what’s measured gets managed, it’s key that ESG criteria are becoming increasingly quantifiable. The growing realisation that ESG constraints on investment options also reduce portfolio risk is further fuelling interest. And perhaps most significantly, the financial system itself is finally being recognised as a unique vehicle for societal progress.
Amid this backdrop, for how will socially responsible investing continue to evolve? And will we ever achieve the clearly defined, quantifiable, standardised set of metrics that also allows for investor discretion necessary to allow for the true mainstreaming of the practice?
Universal ESG standards will emerge
Universal standards are vital, serving as a beacon for conscientious investors and a benchmark against which to test ESG claims. In 2022, debate over the basic tools essential to identifying truly meaningful research and delivery of financial products will likely be settled and financial services companies, or their regulators, will coalesce around at least three ‘gold standards’ of ESG investment.
The first of these will be whether financial management companies review potential investments with a view towards understanding how they improve universal human conditions and planetary ecology. The key here? These standards must be applied to all investment decisions.
Secondly, management companies will also be judged on whether they supplement alignment with these standards by proactively engaging with management, generally through shareholder resolutions or active engagement with executives in their portfolio.
A third key criteria will be the extent to which management companies seek to support the ‘left-behinds’ of capitalism. For example, do they purchase social bonds? Do they invest in indigenous companies?
Together, standards, dialogs, and support for those left behind will help judge the authenticity of ESG claims and separate leaders from followers.
Empowerment and equitable treatment of marginalised groups will rise
The focus on human dignity and wellbeing is rapidly approaching the attention that the environment has enjoyed for these past several years.
Recent debates around racism in the US rapidly spilled over into discussions of other historically disenfranchised groups—from immigrants to the disabled. This has helped expose the common thread; all people deserve dignity and opportunity.
Similar conversations have been happening on a global scale. For example, Japanese companies have focused on gender diversity, while South Africa has improved racial diversity – but both have made less progress on inclusiveness towards other disenfranchised groups.
To build a better future for all, we must move beyond a tick-box culture that focuses on individual diversity indicators and instead adopt holistic standards based on the commonalities between various marginalised groups. This marks the beginning of a 20-year process to develop more inclusive markers of diversity by drawing on data and engagement with a wide range of advocacy groups.
As with any complex issue, there is no one-size-fits-all solution. But what is certain is that corporations and investors have a vital role to play in driving empowerment and equitable treatment.
The single score will end
While the single score has the advantage of offering a bitesize summary for investors, it is a crude measure which fails to offer the nuanced understanding of individual performance metrics such as diversity or highlight subtle differentials between the many measurement systems employed.
The fact of the matter is that the ultimate investor has specific interests; scores will begin to reflect this. There will always be a desire for a product that emphasizes one or another aspect of our work. While each – the E, the S, and the G – are essential in informing the investment management firm, the reality is that the firm will not weigh them equally. They will measure them with their own unique insights in mind.
What’s more, many responsible investors reject the notion that corporate governance should be considered on a par with people and planet. There exist companies with poor governance that provide excellent ecological outcomes. Governance is merely a guide to ever-changing corporate culture. It is increasingly clear that single scores no longer serve their original purpose of providing a yes or a no answer to the question: is this good enough to invest in?
Companies developing sustainable solutions will grow
There is increasing public demand for products and services that contain innovative and sustainable solutions to world problems. Just three decades ago, few companies put thought and effort into producing products that were good for the world. Today, partly in response to investor interest, we see hundreds of companies developing ethical innovations. With tools such as lifecycle assessments, products are also increasingly designed to deliver holistic, whole-life environmental and social benefits.
We see companies innovating with nutritious meat substitutes. We observe transformations in robotics and smart manufacturing that create safer product production. And we see possibilities for the poor expand when clothing is created with recycled plastics and done so in humane conditions. The social purpose of these companies is not merely an afterthought; it’s baked into their DNA. Crucially, these are publicly traded companies which demonstrate that impact is no longer exclusive to the world of private capital.
Investors no longer simply create more ethical companies; they are driving an entire market that encourages start-ups to use capital markets to make a difference. By moving away from a narrow focus on financial ROI and funnelling funding towards companies with an ethical purpose, investors have created space for entrepreneurs who are moved by mission as much as by money.
Standardisation of ESG reporting will increase
Investment managers complain about the difficulties in quantifying non-financial metrics and the consequent major disparities in ESG reporting. Although it can be difficult to develop a standardised definition of a ‘healthy workplace,’ it can be done. If pharmaceutical companies can quantify the value of a little less pain and real estate firms can price a sunset view, why can’t we also quantify ecological and social progress?
Inevitably, environmental impacts will come first; they are easier to measure. But human impacts, as seen by the surge of interest in racial justice this past year, will follow closely behind.
Diverse perspectives will be accepted
It’s possible to find a company in a socially responsible investment portfolio that seems out of place. That’s because impact investors define ethical behaviour in varying ways. Just as two growth investors may draw starkly different conclusions about growth potential from the same financial report, two impact investors may draw different conclusions about a company’s ethical standards from the same data. A good impact investment is in the eye of the beholder. There will always be diverse perspectives on the viability of prospective investments, but the important thing is that ESG is now a key part of that assessment.
The ongoing, lively debates between investors about the varying ESG credentials of their portfolios shows that the process is working. Continuing dialogues between companies and society are real success.
Change will accelerate
Just ten years ago, Exxon Mobil, Chevron, and IBM were among the top ten S&P 500 companies. Today, none of these three even make the top 25. This is, in part, due to millions of individuals joining together in the decision to wean the planet off its addiction to oil. Similarly, the 2019 announcement by America’s Business Roundtable that companies should no longer advance only the interests of shareholders overturned decades of investment orthodoxy.
These changes are indicative of a major paradigm shift that will continue. There are concepts and companies only emerging now that will soon transform the current order. Over time, the influence of responsible investors will further increase the advantages for responsible companies selling safe, useful, and sustainable goods and services. It will make a difference. People are clearly invested in a greater and greener tomorrow and that’s good news for this year—and well beyond.