Sustainable investing is one of the fastest-growing segments of the asset management industry. It is also one of the most complex. This paper aims to provide some clarity on this increasingly relevant topic.
Sustainable investing means looking at “extra-financial” variables, i.e., environmental, social, and governance (ESG) factors (together or separately) when making investment decisions. Such investing may take various forms, from ethical exclusions to comprehensive ESG integration, on the basis of which portfolios may be constructed as best-in-class selection (to maximize extra-financial benefits) or by simply avoiding what may be perceived as unacceptable companies or industries (to either minimize extra-financial detractions or to promote bottom-up ESG change). ESG is a comprehensive field that comprises many dynamics, such as carbon emissions, environmental impact, corporate citizenship, and human capital development. In the industry lexicon, ESG is often distinguished from low carbon (also referred to as “green”). Of course, low carbon is an important component of the environmental dimension of ESG, but it also stands alone in significance due to the global threat of climate change, which is why S&P Dow Jones Indices typically splits sustainability into two categories: ESG and green (low carbon). For our purposes, the environmental dimension of the ESG framework tends to capture more factors, while green tends to focus on a few factors that are considered key in the threat of global climate change. Exhibit 1 further outlines the distinctions between the three dimensions.