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Words Make a Difference….Especially When It Comes to Sustainable Investing

Without the adoption of formal sustainable investing standards and the creation of mutual fund/ETF classifications, decision making on the part of investors will remain inhibited. I. Introduction 

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Without the adoption of formal sustainable investing standards and the creation of mutual fund/ETF classifications, decision making on the part of investors will remain inhibited.

I. Introduction 

When Henry Shilling and I published the research paper “Rapid Growth in ESG Funds Calls for Adoption of Standards” on standards and classifications, in May of 2020, there was a significant divide in the U.S. investment marketplace and affiliated oversight organizations on what sustainable investing was.  In this paper, we proposed three (3) key standard-setting recommendations that included the Adoption of Standardized Definitions, the Creation of Accepted Mutual Fund/ETF Product Classifications, and the Closure of a Disclosure Gap. 

Since that time, the Principles for Responsible Investment (PRI), Global Sustainable Investment Alliance (GSIA), and the CFA Institute recently published the “Definitions for Responsible Investment Approaches” and the SEC has circulated drafts of sustainable investing fund definition and classification rules that are expected to be adopted sometime in 2024.  Although this work provides more clarity, the one standard-setting recommendation that remains untouched is the Closure of a Disclosure Gap.

II. Disclosure Gap 

Demand for increased disclosure has contributed to the emergence of a plethora of sustainability and nonfinancial reporting frameworks and rating agencies.  Despite this uptick in the level of sustainability information, there continues to be a disparity between what is being reported and the information that investors need to make investment decisions.

A Disclosure Gap limits the ability on the part of investors to establish a link between the adoption of sustainable strategies, how such strategies may be impacting investment decisions as well as financial and as relevant and appropriate, non-financial outcomes.  

To illustrate this point, please examine the following six (6) overarching sustainable investing strategies/approaches that we identified in the “Rapid Growth in ESG Funds Calls for Adoption of Standards”.  

  1. Values-based Investing – a strategy based on the guiding principle of investments that are based on a set of beliefs that contain a view toward achieving a positive societal outcome.  Typically, this approach is executed via negative screening, divestiture, or divestment.   
  2. Exclusionary Investing – involves the exclusion of companies or certain sectors from portfolios based on specific ethical, religious, social, or environmental guidelines. Traditional examples of exclusionary strategies cover the avoidance of any investments in companies that are fully or partially engaged in gambling, sex-related activities, the production of alcohol, tobacco, firearms, fossil fuels, or even atomic energy.  These exclusionary categories have been extended, in recent years, to incorporate serious labor-related actions or penalties, compulsory or child labor, human rights violations, and genocide. 
  3. Impact Investing – a relatively small but growing slice of the sustainable investing segment, impact investments are investments directed to companies, organizations, and funds with the intention to achieve measurable social and environmental impacts alongside a financial return.  The direct capital in this strategy addresses challenges in sectors such as sustainable agriculture, renewable energy, conservation, microfinance, affordable and accessible basic services, including housing, healthcare, and education. 
  4. Thematic Investing – an investment approach with a focus on a particular idea or unifying concept.  Clean energy, clean tech, and gender diversity are a few of the leading sustainable investing fund themes.  Investing in green bonds or low-carbon emitting stocks, bonds, and funds also fall into the thematic investing category.      
  5. ESG Integration – the investment strategy by which environmental, social, and governance factors and risks are systematically analyzed and, when deemed relevant and material to an entity’s long-term performance, influence the buy, hold, and sell decision of a security.  For these reasons, ESG Integration is referred to as a value-based investing approach.  
  6. Engagement/Proxy Voting – leverages the power of stock ownership in publicly listed companies using action-oriented approaches that rely on influencing corporate behavior through direct corporate engagement, filing shareholder proposals, and proxy voting. 

If you now compare the terms listed above to those written three and a half years later in the “Definitions for Responsible Investment Approaches” paper (see below), you will find significant agreement on the definition of five (5) of the responsible investing approaches.

  1. Screening – is a process for determining which investments are or are not permitted in a portfolio.  It is used for a variety of purposes, such as attaining an investment focus, complying with laws and regulations, satisfying investor preferences, and limiting risk.  Screening criteria can be based on various investment characteristics, including market capitalization, credit ratings, trading volumes, geographical location, and/or environmental, social, and governance (ESG) characteristics.  Types of Screening include exclusionary, negative, positive, best-in-class, and norms-based approaches.  Screening is applying rules based on defined criteria that determine whether an investment is permissible.
  2. Impact Investing – enables economic activities, which have positive and negative effects on the environment and society.  Impact Investing aims to contribute to or catalyze positive effects (e.g., improvements in people’s lives and the environment) while achieving a financial return.  Impact Investing is intending to generate positive, measurable social and/or environmental impact alongside a financial return.
  3. Thematic investing – involves constructing a portfolio of assets, chosen via a top-down process, that is expected to benefit from specific medium- to long-term trends.  There is a distinction between Thematic Investing, which is an approach for selecting assets to access specified trends, and a “Thematic Fund,” which is a term often used to characterize a portfolio that is focused on a particular interest or area.  Thematic Investing often—but not always—results in a focused portfolio, but not all focused portfolios are the result of Thematic Investing.  Thematic Investing is selecting assets to access specified trends.
  4. ESG Integration – is the incorporation of ESG factors into an investment process, based on the beliefs that ESG factors can affect the risk and return of investments and that ESG factors are not fully reflected in asset prices.  ESG Integration involves seeking out ESG information, assessing the materiality of that information, and integrating information judged to be material into investment analysis and decisions. The details of implementation can vary.  ESG Integration is the ongoing consideration of ESG factors within an investment analysis and decision-making process to improve risk-adjusted returns.

Stewardship – is the accrual of investing institutions’ rights and influence, as a result of being entrusted with the management of clients’ and beneficiaries’ assets.  In this context, stewardship refers to the deliberate deployment of rights and influence (beyond capital allocation) to protect and advance the interests of those clients and beneficiaries.  Stewardship is the use of investor rights and influence to protect and enhance overall long-term value for clients and beneficiaries, including the common economic, social, and environmental assets on which their interests depend.

III. Investor Confusion  

You will also discover that some meaningful differences in these writings can create investor confusion.  For example, if our Values-based Investing and Exclusionary Investing approaches are combined and then dropped into their definition list, the following investor questions should arise:

  • Screening – Is the use of this approach aimed at achieving positive social outcomes, avoiding certain sectors, or limiting risk?
  • Impact Investing – How does one define “financial return”?  Is it market-rate, concessionary, or somewhere in between?
  • Thematic Investing – When does the use of Thematic Investing not result in a focused portfolio?

ESG Integration – Is the consideration of ESG factors voluntary or mandatory in the construction of a portfolio?  How are risk-adjusted returns measured?

IV. Conclusion  

Although there have been some meaningful conversations around the setting of sustainable standards and the creation of mutual fund/ETF classifications, these conversations have not been fortified by the SEC’s publishing their final fund rules.  Without the adoption of such rules, sustainable reporting frameworks will remain unchecked and there will continue to be a disparity between what is being reported and the information that investors need to make investment decisions.  We will continue in our pursuit to close the Disclosure Gap by shining a light on the transparency practices being used in the U.S. sustainable investing space.  Words do make a difference.  

Written by Michael Cosack

February 2024

About the Author:  Michael Cosack has spent most of his professional career advising the trustees on the investment and fiduciary responsibilities regarding their institutional funds. As an entrepreneur, he has built several organizations, including one of the largest independent investment consulting firms in the Greater Philadelphia region, stewarding over $3.5 billion of combined assets. The firm was eventually purchased by a national independent financial advisory firm.

Mr. Cosack has a deep passion and commitment to raising the awareness and impact of sustainable investing. He is a Principal of ImpactWise LLC, Research Liaison of Sustainable Research & Analysis LLC, Chair of the CFA Society of Philadelphia’s Sustainable Investing Thought Leadership Group, and Board Member of ImpactPHL.

Mr. Cosack holds an undergraduate degree in business from The College of New Jersey and has achieved multiple educational designations, including the CFA Institute Certificate in ESG Investing and the USGBC LEED Green Associate Credential. He has taught as an adjunct professor at the University of Pennsylvania’s Fels School and is a frequent contributor to industry conferences.




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