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Sustainable Investing

Industry Definitions

In this article


Understand the definitions used within sustainable investing, such as ‘Corporate Responsibility’ and ‘Impact Investing’.

Key ESG concepts

Corporate Responsibility (CR)

CR is a business model whereby companies commit to and integrate social and environmental considerations into their operations and interactions with stakeholders. It allows businesses to think beyond profits and consider the potential impact of their activities on their customers, employees, communities and suppliers.

ESG

ESG refers to the environmental, social and governance factors of an investment, that may have a material impact on the performance of that investment. The integration of ESG considerations is used to enhance traditional financial analysis by identifying potential risks and opportunities beyond technical valuations.

ESG factors provide a comprehensive picture of a company’s exposure to environmental and social issues, and how they govern such issues. Below is a breakdown of different types of E, S and G factors, and how they might affect a company’s risk and impact profile.

Environmental factors:
Environmental factors reflect how a company performs as a steward of nature. Financial market participants are increasingly recognizing that climate risk is a financial risk. By incorporating factors such as energy consumption, pollution, waste production, and biodiversity protection, investors can mitigate risks and harness the new opportunities arising as we transition to a more environmentally sustainable economy.

Social factors:
Social factors consider how a company interacts with its employees, suppliers, customers and communities at large. These factors include human rights, labor standards, workplace and board diversity, racial justice, community engagement, privacy and data protection, and employee health and safety.

Governance factors:
Governance factors assess how a company is internally managed. Examples of factors within this category include corporate board composition, compliance, executive compensation, and anti-bribery and anti-corruption policies.

Materiality

A factor is material if it will drive long-term financial value in a particular business. Identifying material ESG factors of a potential investment is a key aspect of ESG investing.

ESG Risk Management

ESG risks refer to risks that arise in relation to specific environmental, social and governance issues. There are a variety of ways for investors to manage such risks throughout the investment cycle. Examples include incorporating ESG factors in the due diligence process, using exclusion lists, and actively engaging with investee companies on ESG issues.

ESG risks can be classified as either manageable or unmanageable. Manageable risks are those which can be addressed and mitigated through proper intervention. When a company fails to manage such risks, there is a management gap. Unmanageable risks are those risks which cannot be mitigated by a company.

Risk Exposure

Risk exposure refers to the level of potential loss a company may incur resulting from a specific activity or event, and the likelihood of this loss occurring.

ESG Indicators

ESG Indicators refer to specific data points used to measure the integration of ESG practices, policies and initiatives in investment decisions and processes. The indicators can point to different levels of governance, including the firm, the portfolio, and the asset.

For more information on how these Indicators were formulated, please refer to our methodology: https://docs.preqin.com/pro/Preqin-ESG-Solutions-Methodolgy.pdf

Types of ESG investing and strategies

Sustainable Investing

Sustainable investing refers to investing approaches that aim to promote societal impact and corporate responsibility alongside financial returns. It is a broad term, encompassing a variety of strategies and approaches to incorporating ESG factors into the investment decision process.

Impact Investing

Impact investing refers to investments made with the objective of generating specific, positive and measurable goals that are beneficial to society or the environment. Unlike philanthropy, financial return on the investment is expected. However, it is not the primary driver for the investment, distinguishing it from traditional sustainable investing approaches.

Socially responsible investing (SRI)

SRI is a form of investing whereby investors decrease exposure to assets that are deemed to be less socially responsible, and/or increase exposure to assets promoting ethically and socially responsible themes. SRI is often associated with negative exclusionary screening and positive best-in-class screening.

ESG Integration

ESG integration refers to the practice of explicitly and systematically incorporating ESG issues in the investment analysis and decision-making process. This involves identifying material ESG factors, assessing their potential impacts and incorporating these assessments into the decision-making process to manage risk and enhance returns.

Negative/exclusionary screening

Negative or exclusionary screening is an investment strategy which involves ruling out potential investments based on the investor’s preferences or peer comparisons. Based on these preferences or comparisons, investors can formulate a formal exclusion list containing companies, or even whole industries, that it will not invest in. It is considered one of the largest and oldest sustainable investment strategies.

Best-in-class/positive screening

Positive screening is an investment strategy through which investors identify companies that score highly on ESG factors relative to their peers. It is therefore the opposite of negative screening, which involves filtering out those companies that score low on such factors. Investors often conduct the two forms of screening (positive and negative) simultaneously when identifying potential investment opportunities.

Best-in-class is a subset of positive screening and identifies the leading companies using specific ESG factors within a certain sector or industry.

Ethical and faith-based investing

Ethical and faith-based investing, also known as values-based investing, refers to making investments that maximize returns whilst aligning with certain beliefs and values. Faith-based investors usually incorporate negative screening in their investment decisions to avoid companies whose products or services are deemed immoral according to the investor’s underlying belief or value.

Thematic Investing

Thematic investing refers to selecting companies that fall within specific sustainability-related themes, such as clean-tech, sustainable agriculture, healthcare or climate change mitigation.

Stewardship

Stewardship refers to investors actively utilizing their influence to maximize overall long-term value on behalf of their clients. Investors can influence a broad range of stakeholders, including current or potential investees, policy makers and service providers.

Active Ownership

Active ownership refers to activity exercising one's right as owner of a company. This is mainly done through active engagement and dialogues with the investee company. It is regarded as one of the most effective methods to influence a company's behavior, reduce its ESG risks, maximize returns and enhance its positive impact on society and the environment.

ESG-related affiliations and initiatives

The UN Principles for Responsible Investment (UNPRI or PRI)

The PRI is a United Nations-supported international network of investors. Through committing to six aspirational principles, the signatories of the PRI work together to support the integration of ESG in investment decisions and create a more sustainable global financial system.

Task Force on Climate-related Financial Disclosures (TCFD)

The TCFD was created by the G20 Financial Stability Board to facilitate and improve reporting of climate-related financial information. It provides a set of disclosure recommendations to support informed capital allocation, and enhance market participants’ understanding of material climate-related risks and opportunities.

The recommendations focus on four core areas:

  1. Governance: the organization's governance around climate-related risks and opportunities.
  2. Strategy: the actual and potential impacts of climate-related risks and opportunities on the organization's businesses, strategy and financial planning.
  3. Risk management: the processes used by the organization to identify, assess and manage climate-related risks.
  4. Metrics and targets: the metrics and targets used to assess and manage relevant climate-related risks and opportunities.
Sustainability Accounting Standards Boards (SASB)

SASB is a non-profit organization providing a set of industry-specific disclosure standards across ESG topics. The standards are available across 77 industries, and identify the most relevant ESG issues to financial performance in each industry. Alongside the SASB Materiality Map, these standards help investors determine which ESG issues are material for reporting as well as helping facilitate more standardized benchmarking.

Global Impact Investing Network (GIIN)

GIIN is a global network of investors, focusing on reducing barriers to impact investment by building critical infrastructure and developing activities, education and research to facilitate the development of a coherent impact investing industry.

Global Reporting Initiative (GRI)

The GRI is a global reporting initiative. Through the GRI Standards, they provide guidance on ESG disclosures for investors and other stakeholders.

Global ESG Benchmark for Real Assets (GRESB)

GRESB is an investor-led organization providing standardized ESG data to capital markets. It is considered the leading ESG benchmark for real estate and infrastructure investments.

CDP

CDP (formerly known as the Carbon Disclosure Project) is a non-governmental organization (NGO) supporting companies, financial institutions and cities in disclosing and managing their environmental impact. It runs a global environmental disclosure system in which nearly 10,000 companies, cities, states and regions report on their risks and opportunities related to climate change, water security and deforestation.

Climate Disclosure Standards Board (CDSB)

The CDSB is an international consortium of businesses and environmental non-governmental organizations (NGOs) committed to advancing and aligning the global mainstream corporate reporting model to equate natural capital with financial capital.

Sustainable Development Goals (SDGs)

The SDGs are a set of 17 global goals, established by the UN General Assembly in 2015. The goals address key global challenges, covering issues such as poverty, inequality, climate change, environmental degradation, peace and justice. They are often referred to in the context of impact investing, as a framework for defining and assessing impact.

Institutional Limited Partners Association (ILPA)

ILPA is a global organization dedicated to advance the interests of limited partners and their beneficiaries through education, research, advocacy and events. Through their Due Diligence Questionnaire and Diversity Metric Template, they provide a standardized framework for integrating and monitoring ESG and DEI.

EU Sustainable Finance Action Plan

The EU Sustainable Finance Action Plan is the European Union’s strategy for sustainable finance. It aims to reorient capital flows towards sustainable finance, manage financial risk stemming from ESG issues, and facilitate more transparency and long-termism in financial activities.

The Plan consists of several components, including:

  1. The EU Taxonomy: provides a framework for defining environmentally sustainable economic activities. It identifies three criteria an economic activity must satisfy to be considered sustainable, and a list of six environmental objectives.
  2. The Sustainable Finance Disclosure Regulation (SFDR): imposes a set of disclosure requirements for asset managers and other financial market participants to provide standardized disclosures on how ESG factors are integrated at the entity and product level.

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