Changing the channel on ESG and responsible investing

When Vancity introduced Canada’s first Socially Responsible Investment (SRI) mutual fund, Brian Mulroney was still in his first term as prime minister and Glass Tiger won the Juno as Canada’s most promising new musical group.

Back then, visionary investment professionals, at Vancity and elsewhere, who believed you could invest profitably while trying to make the world a better place were largely dismissed, even laughed at. But more than 35 years of market performance data have validated their ideas and vindicated them.

By and large, SRI funds have delivered strong financial performance. And they have done so while enabling investors to use their investing power to support companies that create positive impact in the world or to prioritize investing in those companies willing to address their exposure to environmental, social and governance (ESG) risks.

Today, SRI is entrenched in mainstream investment management. And ESG is becoming an established component of business oversight and performance. In a recent survey of investor relations professionals, 80 per cent reported an increase in discussions of ESG at the board level, and 55 per cent reported that investors asked questions about the board’s governance structure and ESG processes.

The downside of this development is that many investors are now looking to ESG ratings as a guide for making responsible, impact-focused investments. Their expectation is that a company’s stronger ESG performance means heightened impact performance — for example, a better record of climate action. They also expect ESG data and ratings will help them avoid climate laggards and companies that are using impact actions to mask questionable practices.

This goes a long way to explain the undercurrent of betrayal in the reactions of pundits and investors upon learning of companies with shoddy records and practices earning strong ESG ratings or using ESG to greenwash their performance. Given that ESG methodology is quite subjective, unregulated and not at all standardized, the misappropriation of ESG, while disheartening, is hardly surprising.

But the more fundamental problem is that ESG methodology was never meant to measure or represent the impact a company has on the world or replace SRI. Rather, ESG is a tool for assessing how environmental, social, and governance risks might affect a company’s financial performance.

For investment professionals focused on delivering socially responsible investing, this can be helpful. But it is just one in an arsenal of tools that help them assess the true focus of SRI — the impact that a company is having on people and the planet. Assessing a company’s impact, and the potential for working with a company to improve it, requires a more holistic analysis.

Take Vancity Investment Management (VCIM)’s approach as one example. When we assess whether to hold a stock in one of our funds, we combine a more traditional, growth-focused, fundamental financial analysis with a thorough impact analysis.

Our impact analysis focuses both on impact track record and impact potential, drawing on multiple sources to identify current and future industry impact leaders. We look at environmental impact, human rights, employee relations, diversity, corporate governance, community relations, and sustainable products/services.

ESG data from ratings companies help our impact analysis, but we don’t use an ESG rating as a proxy for impact. Rather, ESG data is one of the tools that help us identify where we need to dig deeper to understand a company’s decisions and actions, do more research or ask more questions of the company.

We also assess the potential for us to work with, and affect, the company’s impact through shareholder engagement, often through meetings with company leadership and information sharing with our engagement partners. We value companies that show a genuine desire to better their impact on people and the planet, even if their current ESG ratings are low.

VCIM, of course, is not the only investment manager working to deliver investment options that combine strong financial performance, strong impact performance, and potential for growth in both. And there will be differences in approach and methodology between different SRI funds and fund managers.

But there is a minimum standard to be met. Today, a fund can market itself as sustainable or as an ESG fund when all they do is apply basic negative screens to exclude certain industries, such as oil and gas. Clearly defined regulations are needed to establish a universal standard and criteria for what counts as a sustainable fund.

But for socially and environmentally minded investors, this isn’t enough. Ensuring you invest in a responsible manner that does good in the world requires a holistic approach that goes well beyond ESG risks to look at the current and potential impact of a company, and its willingness to work with shareholders through shareholder engagement.

Decades of investment performance data show that getting a strong investment return and having a positive impact on people and the planet are not mutually exclusive. Off-the-shelf ESG ratings alone won’t get us there. A strong, holistic, impact-focused in-house analysis, complemented by effective shareholder engagement, will.

Joe Reid is vice-president of impact investing and wealth management at Vancity.