What Is Asset Allocation?
Written by Jason Hiley
Written by Andrew Hunt
As we touched on in our last piece, “Setting the Sustainable Stage,” degrees and kinds of “doing good” are often in the eye of the beholder. How do we measure something that is sometimes so subjective? As described in “Why and How Investors Use ESG Information” (a University of Oxford/Harvard University paper to be published in the Financial Analysts Journal), academics and practitioners alike typically turn to an organization’s Environmental, Social and Governance (ESG) ratings to try to quantify levels of sustainability.
Again, precise labels may vary in the various literature, but following are some of the ways the industry applies ESG ratings into sustainable investment strategies.
Investors currently have access to a range of investment solutions that incorporate these and other strategies to varying degrees.
ESG Investing – ESG investors are more likely to emphasize inclusion strategies, which complement a general evidence-based investment approach. In other words, evidence-based ESG funds should help investors continue to incorporate sound portfolio construction principles (such as asset allocation, global diversification and cost-control), and minimize less-efficient tactics (such as picking or avoiding specific stocks or sectors based on forecasts or popular appeal). ESG fund managers also may engage in active ownership on behalf of their shareholders.
Socially Responsible Investing (SRI) Investing – SRI funds are more likely to use screening strategies that involve making security- or sector-specific judgments or forecasts.
Impact Investing – Impact investors are on a mission to not just invest in a venture, but to become an altruistic partner in it. Say, for example, you donate to a GoFundMe® campaign seeking to create an eco-friendly alternative to plastic water bottles. You’ve just become an impact investor. On a grander scale, high-net-worth investors may take on private equity or debt structures with an eye toward making an impact with their funding.
Finding a Sustainable Fit
None of these possibilities are inherently right or wrong. Which (if any) are right for you? As proposed in this innovative paper, “Sustainable Investing: From Niche to Normal,” it depends whether you are more value– or values-driven. The paper explains that value-driven investors “put financial return first, BEFORE any other issues are addressed,” while values-driven investors will “consider financial return AFTER the investors’ values have been satisfied.”
In this context:
Sustainable investment strategies aren’t mutually exclusive either. For example, you could incorporate ESG investing into the core of your evidence-based portfolio, while participating in impact investing with some of your discretionary income.
Next Up: The Lay of the Sustainable Land
Before sustainable investing existed, investors who were philanthropically inclined had little choice but to seek their financial returns through traditional investing, while separately expressing their personal values by donating to their charities of choice.
Today, solutions are coming into focus for those who would like to begin combining these two, formerly disparate interests. That said, while evidence-based ESG investing holds much promise, it remains a relatively new field of study. Challenges and opportunities abound as we seek to create robust data and enhanced analyses to guide the way – in theory and in practice.
In our next piece, we’ll take you on a fascinating tour of the evolving landscape.