Responsible investment: Where are we now?
Square Mile Research
Jake Moeller, Senior Investment Consultant at Square Mile Research
In 2022, the hitherto strong performance of Responsible Investment (RI) funds suffered a dramatic decline with a considerable portion of RI-classified companies releasing poor results, despite their previous successes. Investors were concerned, unsurprisingly, but their worries are likely to have been in reaction to short-term news stories.
While that is understandable, at Square Mile, we strongly believe that when investing responsibly, a longer-term view is necessary. Taking such a stance is crucial because the issues that RI seeks to address, such as climate change, naturally play out over an extended period.
In fact, the rationale for taking a longer term view is emphasised when exploring the reasons for RI’s poor performance in 2022. Last year, lacklustre results were largely driven by a high inflationary backdrop, which sparked several interest rate hikes by central banks around the world. Given that many RI funds have an equity exposure that focuses on growth assets, these were acutely affected by the hikes thanks to their inherent interest rate sensitivities.
Moreover, as many RI funds have ethical exclusions that restrict exposure to energy companies, performance was further hard hit as the energy sector was easily the best-performing sector, globally, in 2022. Additionally, the requirement to exclude defence stocks has also harmed RI performance due to geopolitical tensions following Russia’s invasion of Ukraine.
In contrast, 2023 has so far been rosier for RI. Inflationary pressures are starting to ease, which should start to signal the end of the current interest rate hiking cycle. While headwinds may persist over the short term, RI funds should begin to benefit from the prevailing market conditions given their more growth-orientated, longer-term positioning.
Effectively gauging the performance of investments, both from an RI viewpoint and financially, requires substantial evidence. While there remain reporting difficulties specifically within the RI space, it is still possible to assess a fund’s commitment to RI.
To begin with, it is beneficial to look at a fund’s marketing materials and see whether they correlate with other key fund documentation. Comparing a Key Investor Information Document with a fund’s factsheet, for example, can provide insight into
whether objectives for the fund are consistent across all materials. Any discrepancies warrant further investigation - either to allay concerns or inform future investment decisions. Investors will also benefit from framing their RI performance investigations with these questions:
What does the fund seek to achieve?
How will the fund achieve its objectives?
How does it choose to measure and report its results?
Once an investor has completed their investigations, they should also delve into a closer examination of a fund’s specific investments. Those investments need to align with an investor's RI requirements and should not raise concerns from conflicting RI goals for the long term.
We find the 3D framework to be a valuable method to assess a fund and its ongoing commitment to RI. The framework evaluates funds against the ideas of ‘do good’, ‘avoid doing harm’, and ‘lead change’. These principles are critical to affecting positive change in relation to the world’s most pressing environmental and social challenges.
Those principles are characterised as follows:
Do Good - Investment in companies offering solutions to global, social and environmental challenges and evidence of 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 practice and inform opinion
In using these labels, an accurate representation of a fund and its performance, from an RI perspective, can be created. Vitally, using this framework protects against greenwashing and instead, ultimately, helps investors pick a product best suited to their demands.
