This article is a starter guide to responsible investment, the first in a series published by Principles for Responsible Investment (PRI).

Responsible investment is defined as a strategy and practice to incorporate environmental, social and governance (ESG) factors in investment decisions and active ownership. Top ESG issues include climate change, resource depletion, modern slavery, bribery, corruption, and tax strategy.

Why should we invest responsibly?

There are several forces driving the growth of responsible investment, first, is the recognition of the materiality of ESG factors and how they can impact risk and return. Second, there is increasing demand from beneficiaries and clients for improved transparency on how their money is invested. Third, regulators and industry norms increasingly consider ESG factors to be part of an investor’s fiduciary duty.

There are two overarching approaches to responsible investment:

1. ESG incorporation which considers ESG issues when building a portfolio. Specific strategies include integrating ESG issues into investment analysis, or screening portfolios for ESG issues and filtering out companies which do not comply with the investor’s ethics or values, or thematic investing which combines attractive risk-return profiles with specific environmental or social outcomes i.e. impact investing.

2. Active ownership or stewardship which improves ESG performance through strategies that increase ESG discussions with companies to improve disclosures of ESG issues and proxy voting to empower shareholders to engage and vote on ESG investment decisions.

Over the last 50 years, there has been growing interest and support within financial services with regards to ESG related topics. Two significant and influential events include the 1999 launch of the Dow Jones Sustainability Indices and the 2015 United Nations Sustainable Development Goals (SDGs). Interest in responsible investment has risen rapidly since the PRI’s launch in 2006, with total PRI signatories now exceeding 2,500 globally. With the rise in global climate emergencies, the ESG industry will grow and the conversation will become more urgent.

However, as the responsible investment sector develops rapidly, it is accompanied by some of the following misconceptions:

• Investments are limited to a single investment strategy or product: this is untrue, in fact, incorporating ESG information in investment decision-making seeks to ensure all relevant factors are included in assessing risk and return. Instead, responsible investment serves to improve risk and return characteristics.
• Investments will lead to a lower return: this is not the case because investors have the advantage to apply a range of new techniques to quickly identify ESG risks and opportunities that would have remained undiscovered with traditional financial investment analysis.
• It’s the same as sustainable, ethical, socially responsible and impact investing: specifically, responsible investments can and should also be pursued by an investor whose sole focus is financial performance.

Responsible investing simply enables investors to use new tools, analysis, and ESG considerations to enhance risk and return characteristics. The PRI is a global organisation that encourages and supports the uptake of responsible investment practices in the investment industry. PRI supports investors with resources, academic research, collaborative engagements, and reporting guidelines.

1. There is a growing recognition in the financial industry and in academia that ESG factors positively influence investor returns.
2. Beneficiaries and clients are increasingly calling for greater transparency about how and where their money is invested.
3. Regulatory change has also been driven by a realisation among national and international regulators that the financial sector can play an important role in meeting global challenges such as climate change, modern slavery and tax avoidance.
4. An example of a financially material environmental risk is the 2010 Deepwater Horizon oil spill, for which BP recorded a US$53.8 billion pre-tax charge.
5. An example of a financially material governance risk is the 2015 incident where Volkswagen was exposed as having rigged 11 million diesel vehicles to pass emissions tests, resulting in costs including €27.4 billion in penalties and fines.
6. An example of a financially material social risk is the 2018 incident where Facebook saw billions wiped from its market value after Cambridge Analytica was able to harvest personal data from 87 million users without their consent.
7. Most regulations related to responsible investment can be grouped into three categories, reflecting various parts of the investment chain: asset owner regulations, stewardship codes and corporate disclosure guidelines.
   
8. Fiduciary duty is the investors' obligation to act in the best interests of beneficiaries. Investors should consider ESG factors consistent with the time frame of the obligation, incorporate the ESG preferences of their clients and beneficiaries and should consider disclosing the process followed.
9. Three significant forces driving the growth of responsible investment include: materiality, client demand and regulation.