You’ve probably heard of “voting with your dollar,” where you spend your money at businesses whose products and services align with your values. But choosing to fly with Air New Zealand over an Aussie rival isn’t the only way you can make an impact.
Today, many investors are not only interested in the financial outcome of an investment decision, but also the impact their investment has in shaping the world they live in.
This is where sustainable investing comes in, helping you express your values and social ideals through your investment, empowering you to put your investment dollars to work towards what you know, love, and want to see grow into the future.
What is sustainable investing?
According to the European Commission, it generally refers to the process of taking due account of environmental, social and governance (ESG) considerations when making investment decisions.
Common examples of ESG factors, include:
This includes a company’s impact on the environment, whether the products it creates are sustainable, and how efficiently it operates.
- Natural resource usage
- Air pollution
- Energy efficiency
- Greenhouse gas emissions
The social factors can be both internal and external to the company, such as how it engages with the community, whether they provide equal employment opportunities, and their overall labour practices.
- Gender and diversity, equal employment opportunities
- Labour standards, training, and qualification support
- Health & safety
- Staff turnover
- Community impact
The impact of the company’s leadership and the standards they set, including how they listen to shareholders.
- Ethical business practices
- Board composition
- Remuneration structures
- Voting rights
Let’s be clear, sustainable investing still seeks to generate positive returns. But it also takes into consideration these non-financial factors, aiming to encourage and benefit from companies focusing on a positive long-term impact on society, the environment, and the world we live in.
ESG vs Socially Responsible Investment (SRI)
Other terms you may regularly hear are socially responsible investing (SRI), ethical investing, and impact investing. In part this is due to a lack of global standards in terminology.
While ESG and SRI investing are both values driven, there are a couple of differences to be conscious of.
Historically, SRI investments have used an exclusions strategy, excluding ownership of “sin stocks” like tobacco or gambling. Sustainable investing often also has these same exclusions, but it might also use a scoring system across the E, S, and G factors of each company to then increase investment in companies which are calculated to be creating a positive impact.
Both of these terms sometimes get referred to as “ethical” investing. At Kernel, we tend to shy away from using the term “ethical”. Our reason for this is because it can be incorrectly interpreted that if something is not labelled “ethical” then it must be “unethical”, which is definitely not the case.
Furthermore, ethics are closely aligned to individual personal values, faith and expertise and what one person considers ethical another finds repulsive.
Given many of these terms are increasingly used interchangeably, yet they can be doing very different things, it’s important to look at the methodology used in the investment strategy to ensure it aligns with your own values and objectives.
Bonus note: Other ways investors can align their portfolio towards a certain value or outcome is through thematic funds – read more here.
How ESG Scores Are Calculated
Part of the sustainable investing process involves calculating an ESG score for each company. There are several leading ESG research firms that calculate scores for a wide range of companies, providing a clear and standardised benchmark for comparing different investments.
The score is calculated from multiple data sources including annual reports, corporate sustainability measures, industry benchmarks, surveys, and modelling of global peers. The rating firm then evaluates and calculates a score across each of the individual E, S & G components.
As an example, TruCost is a global leader in carbon reporting. They use company reported data broken down into nearly 500 business lines to calculate the carbon output of over 15,000 companies around the world. These metrics are then used by rating agencies to calculate an overall ESG score, with the carbon score impacting a companies E rating.
Bloomberg, S&P Dow Jones Indices, MSCI and Refinitiv are a few of the most well-regarded ESG research companies. Scores generally follow a 100-point scale: The higher the score, the better a company performs in fulfilling different ESG criteria.
Why invest in Environmental, Social, Governance (ESG)?
Aside from concerns about environmental and social issues, investors are also looking at sustainable investing as a way to make longer term strategic investment decisions.
When ESG was first coined as a term in 2005 (in a study titled “Who Cares Wins”), it was considered novel and perceived as coming at the expense of better returns.
However, numerous studies have shown that companies which have adopted environmental, social and governance policies have outperformed those that don’t. The logic being companies that are thinking decades in the future and consider their impact on the world may be better positioned to adapt to change and therefore deliver greater long-term returns. Conversely, companies that don’t are penalised in what investors are willing to pay for a share.
There are also regulatory changes to be considered. Government and regulatory support has driven a shift towards sustainable investing as for example, countries transition towards a renewable, low carbon future.
Among them, Germany announced plans to end the use of coal-powered energy by 2038, Norway has banned the sale of internal combustion engine (fossil fuel) cars by 2025, and at home in New Zealand the government has committed to producing 100% renewable electricity generation by 2030.
As a result, we can expect to see companies increasingly consider their social responsibility and acting before regulations force a change. These changes are also having an impact on the financial services sector directly.
Recently New Zealand become the first country to introduce a law that will require banks, insurers, investment managers (like Kernel), and also all companies listed on the NZX (New Zealand stock exchange) to make disclosures reporting the impacts of climate change on their business. The includes explaining how they would manage climate-related risks and opportunities.
How to invest sustainably
Within the universe of sustainable investing there are a wide range of “flavours”. If you plan to engage in sustainable investing you can opt to undertake your own research trying to find out the non-financial information of each company that is of interest to you, or you can look for sustainable funds which align to your values.
You’ll need to make sure you understand what sort of “flavour” the sustainable fund is operating under, for example are they just excluding companies in certain sectors or are they also tilting the investment towards companies that are doing good.
The benefit of using a sustainable fund is you can save time on research and rest easy knowing your money is being spread across a diversified range of companies using some of the best independent global research available.
Sustainable investing with Kernel
To enable investors’ portfolios to adapt to the times and follow the rising awareness of sustainability in investing, we have just announced that we will be launching three new sustainable funds in the coming weeks.
We’re passionate about enabling investors to invest with the environment, our society and good business practises in mind.
To be the first to know when we launch our new sustainability funds, be sure to register below!