Abstract
Socially Responsible Investment (SRI) has grown exponentially in recent years. The rising importance of social, environmental, and governance (ESG) aspects in decision making as well as in asset allocation is undeniable. However, important challenges must be addressed. The dramatic increase in ESG investments has coincided with a period of extremely low rates and massive liquidity injections. Also, the definition of socially responsible investment is too broad and can generate misunderstandings (an approximation to the correct definitions can be found in Sandberg et al., 2009). Additionally, I find that a significant part of funds that follow ESG principles can fall into the trap of investing in heavily subsidized and high-debt sectors. Investors should monitor the risk of concentration, the soundness of profit estimates, and strength of balance sheets to avoid rent-seeking and depending heavily on subsidies and grants. Furthermore, I find that performance of ESG and SRI funds has been monitored only in a period of low rates, high liquidity, rising asset valuations, and bullish markets. More tools have to be used to monitor risk as markets enter a consolidation phase. I find that it is essential to focus on real economic returns in a mid-cycle environment as well as monitoring excess leverage to avoid the risk of a very important reduction in ESG investments in a market correction phase for markets with rising interest rates. I conclude that strong fundamental analysis, diversification, and avoiding herd mentality are essential to prevent large outflows and a negative impact on ESG growth once the cycle changes.
Highlights
In broad terms, Socially Responsible Investment (SRI) can be defined as an investment approach that considers environmental, social, and governance (ESG) factors in portfolio selection and asset management
The definition of SRI can be broad and heterogeneous (Sandberg et al, 2009), I focus on the Global Sustainable Investment Association (GSIA) definitions of sustainable investment, which have emerged as a global standard of classification
Impact/community investing: targeted investments, typically made in private markets, aimed at solving social or environmental problems, and including community investing, where capital is directed to traditionally underserved individuals or communities, as well as financing that is provided to businesses with a clear social or environmental purpose; and
Summary
Responsible Investment (SRI) can be defined as an investment approach that considers environmental, social, and governance (ESG) factors in portfolio selection and asset management. Companies find that investing without considering ESG does not generate higher profitability, but they find that costs of not following ESG and socially responsible principles are rising, both from a corporate image perspective as well as in earnings, as fines and penalties reach multibillion US dollar figures.
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