How do managers use ESG to invest sustainably?

Asset managers that offer sustainable investments use an environmental, social and governance (ESG) framework in their investment decision making. Read more: What is ESG?

Managers make use of the ESG framework to make their investment decisions in one or more of the following ways:

• Integration into the investment process

Asset managers may consider ESG factors together with the traditional financial factors when analysing shares and bonds and making investment decisions. ESG factors will play a role in the choice of securities but this does not necessarily mean they will only invest in shares or bonds that rate well on ESG factors.

• Screening

ESG factors may be used to exclude or screen out from the choice of shares or bonds those that fare poorly on these factors.

For example, a manager may screen out businesses involved in the manufacture of weapons and ammunition or in the mining or processing of fossil fuels.

If a manager screens out certain securities it should make this clear in the description of the investment strategy.

Screening may not be suitable when a manager is investing in a small concentrated market or one dominated by an industry that ranks poorly in ESG factors, such as the mining industry. South Africa has both these characteristics.

Large scale screening may have negative implications – for example, creating unemployment in a sector.

Screening can have a big impact on investment performance relative to a benchmark depending on whether or not the excluded shares or bonds perform well over a particular term or not.

• ESG-themed investing

Some asset managers and index-tracking investments have a mandate to focus on investments that score well on ESG considerations.

Some managers invest only in sectors that are positioned to take advantage of certain ESG themes – for example, a climate change theme may focus on renewable energy, green buildings, electric cars and green bonds that finance environmental projects.  

• Impact investing

Managers who practice impact investing typically fund listed and unlisted projects that aim to deliver positive, measurable environmental or social outcomes.

Impact investments include those in infrastructure, sustainable agriculture, renewable energy, microfinance, and basic services such as housing, healthcare, education and job creation. 

These projects require manager expertise and longer investment horizons, and a means to measure the impact achieved.

• Active stewardship

Active ownership of shares or active stewardship can consist of engagement and / or proxy voting.

Engagement

Managers and large investors can use ESG factors to actively engage with the management of companies with a view to getting them to improve disclosure of ESG issues or business practices with an ESG impact.

Managers and investors may engage with companies individually or in collaboration with other investors. However, in South Africa managers need to adhere to competition legislation that prevents them from “acting in concert”.

Voting

Managers may also use shareholders’ proxy votes to vote against company resolutions that do not further sustainable business practices or impact ESG issues.

Index-tracking investment companies, whether their indices are ESG focussed or not, are still deemed to be long-term holders of shares and must play an important role as active shareholders.

• Combinations of the above

Since asset managers’ different strategies involve different risks and opportunities, you should be comfortable with the approach your manager takes. Stay informed, keep monitoring the reported outcome of the manager’s approach and ask questions.

WAYS IN WHICH A MANAGER MAY USE YOUR INVESTMENTS TO INVEST FOR GOOD
ESG integration	Screening	Thematic investing	Impact investing
ESG factors are considered when shares, bonds and other securities are analysed and chosen.	ESG issues are used to screen or exclude shares, bonds and other securities from the portfolio.	Shares, bonds or other securities are chosen based on one or more ESG issues or themes.	Investments are made into projects – often unlisted – that target a specific impact on the environment or society.

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Based on a table published by the UNPRI: 

What is responsible investment? | Introductory guide | PRI (unpri.org)