Environmental, Social, and Governance Investment Approaches

ESG considerations are incorporated in investment choices through responsible investing. The essence of doing so is to reduce risk, preserve asset value, and prevent unfavorable social or environmental effects.

The concept of sustainable investment involves choosing assets and businesses on the basis of their perceived ability to provide value on all three fronts: economic, environmental, and social.

Investors who participate in socially responsible investing (SRI) select assets and businesses that match their social, moral, or religious values. SRI takes environmental and social considerations into account when making investment decisions.

Value-based and values-based investments are both types of ESG investing. Value-based investing aims at reducing risk while including important ESG factors and conventional financial indicators in investment research. Values-based investing, on the other hand, aims at making financial decisions that reflect or advance an investor’s moral or religious convictions.

ESG Investment Approaches

There are six common ESG investment approaches:

1. Negative screening.
2. Positive screening.
3. ESG integration.
4. Thematic investing.
5. Engagement/active ownership.
6. Impact investing.

1. Negative Investing

This uses criteria based on an investor’s preferences to exclude particular industries, businesses, or practices from investment. Negative screening examples include the exclusion of alcohol producers or businesses with dubious human rights policies.

2. Positive Screening

This involves picking certain industries, businesses, or ways of doing things according to an investor’s preferences. It targets well-managed ESG risks in comparison to peers with the best rankings. Positive screening employs an ESG rating methodology. An example would be looking for businesses that value diversity at the workplace.

3. ESG Integration

This attempts to accomplish a portfolio’s stated investment objectives. It requires systematic evaluation of significant ESG aspects in asset allocation, securities selection, and portfolio building choices. Financial analysis includes ESG considerations.

4. Thematic Investing

Investing in ESG-related assets relates to ESG factors such as sustainable agriculture, gender diversity, and renewable energy. This strategy is based on demands brought about by societal or economic developments. Among others, such developments include rise in the need for water and energy and accessibility of substitute sources.

5. Engagement/Active Ownership

Through direct corporate involvement, submission of shareholder recommendations, and proxy voting that follows ESG criteria, shareholder or bondholder rights are used to affect business conduct. Along with financial gains, this aims to fulfill certain social, environmental, or governance objectives. Multiple investors work together to involve management in collaborative engagement in order to positively impact the management of their significant ESG risks.

6. Impact Investing

This type of investment aims at producing a financial return as well as beneficial, quantifiable social and environmental effects. One illustration is investing in businesses that are working to fulfill one of the UN Sustainable Development Goals (SDGs).

Question

Which of the following is most likely an ESG investment approach that attempts to achieve a financial return and at the same time has a quantifiable social and environmental effect?

1. Impact investing.
2. ESG integration.
3. Negative screening.

The correct answer is A.

Impact investing is a type of investment that aims at producing a financial return and beneficial, quantifiable social and environmental effect. A good example is investing in businesses that support one of the UN Sustainable Development Goals (SDGs).

B is incorrect. ESG integration attempts to accomplish a portfolio’s stated investment objectives. This requires systematic evaluation of significant ESG aspects in asset allocation, securities selection, and portfolio building choices. Financial analysis includes ESG considerations.

C is incorrect. Negative screening uses criteria based on an investor’s preferences to exclude particular industries, businesses, or practices from investment. Negative screening examples include exclusion of alcohol producers or businesses with dubious human rights policies.