Investors should value companies not on what they do but how they do it, argues Rory Sullivan

Responsible investment is increasingly seen as a standard part of mainstream investment practice. From a standing start five years ago, the UN-backed Principles for Responsible Investment (PRI) now have more than 900 signatories, including more than 500 asset managers and almost 250 asset owners.

A significant proportion of PRI signatories are in the process of integrating consideration of environmental, social and governance (ESG) issues into their investment research and decision-making processes, and encouraging companies to improve their reporting and management of a range of ESG issues.

The growing attention being paid by investors to ESG issues has – alongside the pressures exerted by governments, NGOs and other stakeholders – had an important influence. Many large companies have now adopted formal environmental and social policies and have established clear accountabilities for the management of these issues. The number of companies reporting on their social and environmental performance (both in stand-alone reports and to initiatives such as the Carbon Disclosure Project) has increased year on year.

Yet, despite all this progress, virtually all of the major indicators of pressure on the natural environment – greenhouse gas emissions, resource consumption, biodiversity and ecosystem loss – continue to deteriorate. The trend suggests there is a critical need to move the corporate responsibility debate on from management systems, processes and reporting, towards an explicit focus on social and environmental impacts and performance.

If we are to make this change, we need a corresponding shift within the investment industry. Investors, individually and collectively, will need to focus on four key questions:

• What exactly is being invested in? This relates both to the absolute amounts of money being invested in areas such as renewable energy, as well as how these compare to the scale of investments in, for example, the energy or oil and gas sectors.
• What are the ESG characteristics of investment portfolios? It is striking – with some notable exceptions such as Henderson Global Investors’ efforts to determine the carbon footprint of some investment funds – how little analysis there has been of the ESG characteristics of investment portfolios as a whole. It is virtually impossible to assess whether the overall social or environmental performance of an investment portfolio has improved, deteriorated or stayed the same over a period of time.
• What outcomes have been achieved through investor engagement with the companies invested in? 
• What outcomes have been achieved through investor engagement with policymakers?

While these four questions sound radical in the context of current investment practice, there are signs that at least some investors are starting to think this way about their responsible investment activities.

Examples include the group of investors that are supporting the Carbon Disclosure Project’s Carbon Action Programme (which is encouraging companies to publish greenhouse gas emissions reduction targets and to make year-on-year reductions in those emissions). Another is the more than 200 investors that have supported the call by the European Institutional Investors Group on Climate Change and its sister organisations around the world for an international climate change treaty that sets and enforces clear long-term greenhouse gas emission reduction targets that ensure the worst consequences of climate change are avoided.

Better reporting

This need for a change in emphasis is reflected by the new signatory reporting framework being developed by the PRI. The framework, which all PRI signatories will be required to report against, includes questions on asset allocation, engagement processes and outcomes, and public policy engagement. The framework also encourages investors to provide information on innovative approaches to responsible investment, such as different engagement strategies and the measurement of the social, environmental and financial implications of responsible investment activities.

A performance-oriented rather than a process-oriented approach to responsible investment inevitably raises complex questions such as how the social and environmental characteristics of investment portfolios can be assessed, what the limits are to investors’ influence, and how investors can maximise their influence and effectiveness.

Perhaps the most difficult question of all is what exactly investors should do when sustainable development goals conflict with their financial interests. In answering this question, we must not lose sight of the fact that responsible investment (and its earlier incarnations in socially responsible investment) was originally conceived of as means of addressing and reconciling the social, environmental and ethical dimensions of investment.

In other words, the primary measure of the effectiveness of responsible investment, whether at the level of the individual investment institution or across the investment industry as a whole, must be the contribution that is made to the delivery of sustainable development goals.

Dr Rory Sullivan is a strategic adviser at Ethix SRI Advisers, a senior research fellow at the University of Leeds and a member of the Ethical Corporation advisory board.

He will be chairing Ethical Corporation’s Sustainable Finance Summit in London on 6 and 7 December.