By Daniel Archibald | CFA
Throughout the late 20th century, the dominant role of business was to generate profits. The ideals of shareholder primacy meant that company boards and executives were tasked with growing the firm's bottom-line with little regard for other stakeholders to the firm - e.g. employees, suppliers, creditors, etc. However, over the last few decades the importance of managing the interests of all stakeholders, especially those that have little direct voice (such as the environment), has grown substantially.
In today's investment world, most fund managers are aware of this added driver of business performance. This has largely been driven by investor demand for socially-responsible investments. There is also ample evidence that firm's that prioritise socially-important outcomes also tend to perform well from an economic point of view: the ultimate Win-Win. Thus, portfolio managers have been keen to incorporate ethical investment techniques and tools within their decision-making processes.
In general, investors can incorporate different levels of socially-driven portfolio construction, which include:
- Negative screens - This is the process of 'black-listing' certain industries and individual firms from the investable universe. This includes banned targets such as guns, tobacco, fossil fuels, gambling and users of slave labour.
- Positive screens - This is the process of limiting the investable universe to industries or firms with strong environmental, social and governance (ESG) practices.
- Thematic investing - This type of investor will look to support specific industries that are making a big difference in socially-positive outcomes. This is currently dominated by renewable energy generation, storage and distribution.
- Activist investing - Large investors might look to make a difference by taking significant holdings in firms where the marginal propensity for ethical change is high. Activist investors will generally seek board positions in order to facilitate greater ESG practices.
- Impact investing - This type of investor places the generation of social impact above financial return, looking to support businesses and smaller programs that have largely altruistic objectives.
The trend towards ethical and sustainable investing is likely to continue to grow, driven by ongoing fears of climate change effects and greater awareness of other negative externalities. This presents opportunities for investors to build more diverse portfolios, which also encompass the non-monetary goals and objectives of investors.