Understanding Responsible and ESG Investing key definitions

The landscape of responsible and Environmental, Social, and Governance (ESG) investing is nuanced and diverse, characterised by a variety of terms and approaches. Organisations such as the CFA Institute, Global Sustainable Investment Alliance (GSIA), and Principles for Responsible Investment (PRI) offer varying definitions and frameworks, reflecting the evolving nature of this field. The following definitions are based on the UN Principles for Responsible Investment interpretation.

Screening

Screening is a process used to determine which investments are allowed in a portfolio. This method serves several purposes, including achieving a specific investment focus, complying with laws and regulations, meeting investor preferences, and limiting risk. The criteria for screening can include various investment characteristics such as market capitalisation, credit ratings, trading volumes, geographical location, and environmental, social, and governance (ESG) factors. The application of screening based on ESG characteristics is discussed below.

Definition: Applying rules based on defined criteria that determine whether an investment is permissible (PRI).

ESG integration

ESG integration involves incorporating environmental, social, and governance (ESG) factors into the investment process. This approach is based on the belief that ESG factors can influence the risk and return of investments and that these factors are not fully reflected in asset prices. ESG integration entails gathering ESG information, evaluating its materiality, and incorporating material information into investment analysis and decision-making. The specifics of how this is implemented can vary.

Definition: Ongoing consideration of ESG factors within an investment analysis and decision-making process with the aim to improve risk-adjusted returns (PRI).

Thematic investing

Thematic investing involves constructing a portfolio of assets selected through a top-down process, targeting those expected to benefit from specific medium- to long-term trends, including ESG trends. It is important to distinguish between thematic investing, an approach for selecting assets to capitalise on specified trends, and a "thematic fund," which generally refers to a portfolio focused on a particular interest or area. While thematic investing often leads to a concentrated portfolio, not all concentrated portfolios result from thematic investing.

Definition: Selecting assets to access specified trends (PRI).

Stewardship

Investing institutions gain substantial rights and influence by managing clients' and beneficiaries' assets. In this context, stewardship refers to the intentional use of these rights and influence (beyond mere capital allocation) to safeguard and promote the interests of those clients and beneficiaries.

Definition: The use of investor rights and influence to protect and enhance overall long-term value for clients and beneficiaries, including the common economic, social, and environmental assets on which their interests depend (PRI).

Impact investing

Investing drives economic activities that can have both positive and negative impacts on the environment and society. Impact investing seeks to foster or accelerate positive outcomes, such as enhancing people's lives and the environment, while also delivering financial returns. 

Definition: Impact Investing: Investing with the intention to generate a positive, measurable social and/or environmental impact alongside a financial return (PRI).

Conclusion

By comprehending the diverse definitions and methodologies inherent in responsible and ESG investing, investors can better align their portfolios with their ethical principles and financial goals. As responsible and ESG investing continues to evolve, these standardized definitions and frameworks serve as invaluable tools, empowering investors to make informed and impactful decisions that not only yield financial returns but also contribute positively to society and the environment.