Navigating through the consolidation of Responsible Investment
Square Mile Research
Jake Moeller, Associate Director - Responsible Investment at Square Mile Research
After a challenging year in 2022, many Responsible Investment (RI) funds bounced back in 2023 as soon as investors noticed that assets had been oversold when inflation and interest rates soared. Moreover, despite temporary higher funding costs for many companies, regulation in the UK has strengthened the sustainable agenda, showing the market that RI only had a hiccup.
Over the last few years, Square Mile has not ceased to work with asset managers and independent financial advisors to encourage best practices and help our clients make informed decisions. Aware that the RI universe has broadened, we have kept a close eye on new trends, regulatory standards, and products across the industry.
Following a challenging period of high inflation (mentioned in the last Good Investment Review), inflationary pressures in the UK have abated slightly. This trajectory increases the likelihood of interest rate cuts which is largely good news for companies in general, including those within the RI space. Businesses providing environmental and social solutions often need substantial amounts of external funding, whose costs vary with interest rates.
The rapid growth of RI has led asset managers to enhance their research and stewardship processes. Engagement with companies has been generating a measurable and meaningful positive impact on the environment and society due to efforts around active ownership, climate disclosures and nature-related concerns, among others.
For example, the Taskforce on Nature-related Financial Disclosures (TNFD) has been highlighting the importance of nature conservation, restoration and sustainable use of resources. Many companies have been assessing their upstream and downstream value chains to better understand and address (potentially material) nature-related issues.
Furthermore, the UK Financial Conduct Authority (FCA) released its highly awaited Policy Statement PS23/16, Sustainability Disclosure Requirements (SDR) in November last year. The paper seeks to set several mandatory requirements to inform and protect customers while improving general trust in the sustainable investment market.
Square Mile believes that the SDR is a positive regulatory initiative that, in conjunction with decreasing inflation, expected interest rate cuts, and better practices performed by asset managers, will take the market through a consolidation stage that is likely to favour RI in the long-term.
Given the growth experienced in the space, investors can find a vast range of different strategies for tackling distinct challenges and offering thematic solutions. For example, there are funds focused on water & sanitation, climate change, biodiversity restoration, health evolution, nutrition, and smart cities, among others.
Across the industry, reporting has improved substantially, and funds have been demonstrating tangible examples of their commitment to tackling environmental and societal challenges. Most funds dedicated to sustainable investment publish annual ‘Impact or Sustainability Reports’ including metrics and case studies regarding the positive impact generated by investee companies.
At Square Mile we assess the commitment of funds to responsible investment via the 3D Framework. Such method evaluates funds under the pillars of ‘doing good’, ‘avoid doing harm’, and ‘lead change’ and are further explored below:
Do Good: investment in assets offering solutions to global social and environmental challenges and evidencing impact.
Avoid Harm: avoidance of investment in companies making a significant negative contribution to society and the environment and those exposed to controversies.
Lead Change: advocacy and engagement with investee companies both individually and through cooperation with other investors and change activists to encourage best practices and inform opinion. Strong research processes, company culture, and stewardship, at a company and fund level.
The 3D process is comprised of data collection & processing, revenue-source analysis, assessment of alignment with environmental and/or social matters, and qualitative opinion. Once a fund’s portfolio has been run through the framework, each fund will achieve a 3D Rating and an associated medal.
