Catherine* had an investment portfolio that was performing well but she had a desire to switch her investments to ones that better served the environment. She decided to start her own research to learn more about the options available.
Catherine had heard a lot in the media about ESG investing and sustainable investing but didn’t know the difference between the two.
ESG is a set of criteria used to evaluate environmental, social, and governance factors. It is a subset of sustainability which includes economic considerations.
–Environmental incorporates climate change, natural resources, pollution, waste and environmental opportunities.
–Social relates to human capital, product liability, stakeholder opposition and social opportunities.
–Governance refers to corporate governance and corporate behaviour.
The purpose of ESG is to provide stakeholders and investors with a framework to assess a company’s positioning with respect to its societal, environmental and governance risks and opportunities. Sustainability is operating a business in a way that meets the economic, social and environmental needs of the present without compromising the ability of future generations to meet their own needs.
Both ESG and sustainability are concerned with environmental, social and governance factors, but while ESG evaluates a company’s performance based on these factors, sustainability is a business principle. ESG measures carbon emissions, diversity and inclusion, and executive pay. Sustainability covers a range of topics including supply chain management, stakeholder engagement, and community development.
While ESG investing and sustainability investing are referred to interchangeably, they reference different things.
As an investor Catherine decided that environmental and social efforts were more important to her than governance and started to look for investments that were in line with her desires. The first step Catherine took was to consider what part of ESG (Environmental, Social and Governance) was important to her.
Presently, there is no standardised measurement of a company’s ESG rating, meaning companies might score differently depending on the agency that is rating them. On the other hand, when looking at the investment options available to her, Catherine could consider how they were classified under Sustainable Finance Disclosure Regulation (SFDR), an EU regulation introduced to prevent greenwashing, which is a form of advertising that deceptively uses green public relations to persuade investors that a financial instrument is environmentally friendly. Therefore, SFDR improves transparency in the marketing of sustainable investment products.
Under SFDR, funds are classified in three categories: Article 6, Article 8 and Article 9.
Nearly all of Catherine’s investments fell under Article 6. This meant that the financial instrument did not integrate ESG factors or sustainability as standard. There could be ESG factors to the investment, but ESG factors were not considered in the design of the financial instrument. One of her investments was categorised under Article 8 which meant it integrated ESG factors as standard.
Article 9 investments were also available to Catherine. These are financial products that have a sustainable investment as an objective and focus on funds targeting specific sustainability themes.
Catherine also had the option of diversifying her portfolio with green bonds. Green bonds work the same way as normal bonds, but the money raised for them is specifically allocated to projects that positively affect the environment or they contribute to the fight against climate change. One thing that Catherine had to consider with this investment was that green projects have a long-term timeline, especially if the project is building some kind of green infrastructure. Thus, the bond issued to finance the project will also have a long-term timeline. As an investor Catherine had to accept the longer duration and additional duration risk.
After Catherine’s research she learned that she would be able to have a greener portfolio without compromising any returns.
*Names have been changed to protect client anonymity.