Responsible Investing: Terminology and Background

In recent years there has been a rise in available investment strategies and governance considerations to help investors adapt to evolving challenges in the responsible investing space. Norms and culture surrounding the idea of what it means to be a prudent person, and the legal responsibility of fiduciaries, is being debated in a time of heightened politicization of many topics. It also continues to shift as more data brings to bare evidence of materiality and opportunity for both societal and financial benefit.

THERE ARE THREE MAIN CATEGORIES OF RESPONSIBLE INVESTING IN INVESTMENT MANAGEMENT TODAY:

• Environmental, social and governance (ESG) investing is an investment practice that involves systematically integrating the three ESG factors into fundamental investment analysis to the extent that they are material to investment performance. This is often deemed a risk management framework.
• Negative screening (synonymous with “socially responsible investing” or SRI) is a portfolio construction process that attempts to avoid investment in certain securities or industries through negative screening according to defined ethical guidelines.
• Impact investing is investing in projects, companies, funds or organizations with the express goal of generating and measuring mission-related economic, social or environmental change alongside financial return.

These strategies can serve different but overlapping purposes in a portfolio. For example, integrating ESG factors into investment decisions as a risk framework aims to improve long-term investment performance. Yet divesting from fossil fuels to mitigate transitional, physical, or reputational risk, could also be viewed as an ESG strategy—when considering the risks potentially associated with those investments—or a mission-related negative screen.

As such, some frameworks, including the United Nations Principles for Responsible Investing (PRI), include both negative screening and thematic investing as an ESG tool. Impact investing, on the other hand, explicitly focuses both on financial and non-financial outcomes and allows investors and committees to move resources directly toward mission-specific goals. Further, there are passive and active strategies for investors to consider, and they can be integrated across all asset classes. These strategies can also be thought of as being on a continuum, from mission alignment, in which negative screens are used to ensure investments do not run counter to the mission of the institution, to portfolio integration of ESG factors, and finally to mission impact, in which investors seek returns while having a direct impact on mission. Data reported in the Commonfund Benchmarks Studies show that over the past 10 years more and more institutions are taking steps to either be on this continuum or to progress within it.

To learn more about responsible investing, download our whitepaper, "Navigating the ESG Landscape."

The goal of this work is to provide a road map to responsible investing for governing boards and committees who are considering whether and how to integrate environmental, social and governance factors into their investment process.