Responsible investing has become a megatrend that is shaping the financial markets. There is a wide range of responsible investment opportunities available but comparing them is challenging. Responsibility cannot be measured with a ruler. Depending on the chosen responsibility criteria, the portfolio can look quite different. An investor can easily get lost in the unstructured information flow. Should investors put responsibility considerations aside for the time being and embrace responsible investing once the situation has calmed down a bit?
In the aftermath of the 2008 financial crisis, the financial markets have changed in many ways. The increased role of the central banks, technological disruptions, the pandemic and the stretching of the traditional investing principles have challenged all investors. However, the most significant long-term change has probably been the growing importance of responsible investing. Responsible investing has become mainstream. A decade ago, asset managers used to approach institutional investors like Veritas with a focus on returns, but today, responsibility is a key sales argument.
The pace of change is not going to slow down. In fact, it is going to accelerate. To keep up with the development, investors need to devote an ever-increasing portion of their time to responsibility issues. New responsible investment products are launched frequently and regulation concerning responsibility is progressing fast, especially regarding reporting. It feels like new policies and practices are emerging before you have even had time to implement the old ones properly.
How, then, can you be a responsible investor? Asset managers offer us a broad range of responsible products, so one might imagine that responsible investing is quite straightforward. That is not, however, the case.
If an investor is comparing responsible investment strategies in emerging equity markets, there are plenty of options available. With a focus on social and governance aspects, Chinese companies often end up being underweighted in the portfolio. However, if climate factors are emphasised, then China may be significantly overweighted due to its tech companies with low carbon emissions. To be responsible, investor should both overweight and underweight China. The situation is contradictory.
Responsibility may be a problematic issue even for those who invest directly in individual stocks. ESG data and ratings are available from a multitude of sources, so one might think that comparing companies would be easy. However, it is possible for a manufacturer of zero-emission electric cars to score lower in terms of environmental responsibility as compared to a competitor that produces fossil-fuel powered cars if the assessment of the environmental impact only includes the raw materials used in the production. If the entire lifecycle of the product and the positive impacts on the advancement of environment-friendly technologies are considered, the conclusions can be quite different.
There is more than one solution
Institutional investors like Veritas quite often solve the responsibility dilemma through profound understanding and evaluation of investment strategies. For example, when considering a new actively managed strategy, we do plenty of research and conduct in-depth discussions with the team managing the strategy. Unfortunately, for non-professional investors this is usually not possible. What could be of help for both smaller and larger investors trying to navigate through responsibility issues?
One approach is to apply Hume’s guillotine. According to the principle it is not possible to derive moral rules from facts. When applied to responsible investing, the principle could be formulated so that individual investors must first consider what responsibility means for them before choosing responsible investment solutions. If each investor follows this principle, capital will be allocated to investments that are in line with our aggregated view of responsibility. The outcome is closely related to democratic elections: investors vote for their preferred flavour of responsibility with their own investments. Thus, we can rely on the power of the masses and confidently advance along our own path of responsible investing. In case we forget to consider any aspect of responsibility, someone else probably has weighted that aspect more. When our decisions are based on our values, we will not participate in the modern indulgence trade, but rather, we are genuinely engaged in making a better world, one investment at a time.
The rapid development of the field may help making responsible investment decisions in the future. Along with the accumulation of responsibility data, the advancement of research in the field and the harmonisation of practices, it will be much easier to take responsibility perspectives into account in investment activities. We would like, however, to encourage everyone to become a responsible investor already today. Responsibility is found in each of us!
Read more about the principles that guide us at Veritas under Responsible investment.