Value-Based Investments in Sustainability
The term value-based investments focuses on incorporating environmental sustainability-based ethical principles and moral beliefs into the investment directives, approaches, and goals of investors and companies.
Value-based investments have become a major topic of discussion in the twenty-first century with more attention and greater amounts of capital chasing this category each year. Value-based investments in sustainability tend to encompass the same strategic goals as impact investing and environmental social, and governance (ESG), as well as, socially responsible investing (SRI). In more recent years, specialized investment products, sustainable corporate goals, prominent university research, and investor activism have spurred a rapid development of the lens through which investments are examined. In spite of all the activity in this nascent categorical proliferation, there is an absence of a uniform definition of value-based investments and corresponding ambiguous boundaries for related terminology. As a result, the question of what qualifies as a value-based investment remains the subject of debate. In general, any investment can have a positive social impact, but it depends on each investor’s definition as determined by his/her own values (Bugg-Levine and Emerson 2011, p. 9). The ideology and drivers behind value-based investments are defined primarily through activist investors as well as private corporate social responses (Höchstädter and Scheck 2015).
A portion of investors today believe that maximizing their financial return is not sufficient. These investors aspire to craft portfolios that are able to become an extension of their beliefs and core values. In this scope, investors seek to select a portfolio of stocks comprised of investments that align to corporate practices and business activities that support the investor’s principles (Harji and Jackson 2012). Value-base investing is an outcome of this investment strategy. As of the current writing of this entry, there are now over 1400 global institutional investors signatories to the United Nations’ Principles for Responsible Investing Initiative and more than $6 trillion invested in mutual funds, separate accounts, and institutions with a value-based social responsibility mandate (Key 2015). As value-based investing becomes more and more mainstream, investors are taking advantage of greater opportunities to align their own interests and values with their investment objectives.
Background and History
Value-based investing has a long history, but only in recent years has it become a mainstream topic. As early as the eighteenth century, founder of the Methodist Church John Wesley outlined tenets for ethical investing focusing on values such as avoiding investments in industries that harm a worker’s health (Youseff and Whyte 2013). Additional historic examples include the development of finance institutions such as the Commonwealth Development Corporation in the UK and the World Bank’s International Finance Corporation, established in 1948 and 1956, respectively (O’Donohoe et al. 2010). The world’s first sustainability value-based investment fund, PAX World Fund, was introduced in 1971, offering a vehicle for those against nuclear arms production. In 2007, the similar strategy “Impact Investing” was coined by the Rockefeller Foundation, and the investment strategy focused on investments with a positive social and environmental impact (Höchstädter and Scheck 2015). Presently, under the umbrella of value-based investments are three strategies with differentiated targets related to social and environmental impact: socially responsible investing (SRI), ESG (environmental, social, and governance) factor investing, and impact investing.
Definition of Value-Based Investments Through Categorical Explanation
Socially responsible investing (SRI) is part of the overall principle of value-based investing and seeks to align an investor’s values and beliefs with his/her investment by screening out companies or industries based on specified criteria (Sullivan 2010). Originally, faith-based institutions developed the strategy to screen out stocks and businesses that were morally objectionable and against their values and beliefs. Some common examples of screen filters include stem cell research, adult entertainment, firearms, gambling, tobacco, child labor, carbon emissions, alcohol, animal welfare, abortion, and nuclear power (Wine 2009). The level of screen can be adjusted to match an investor’s preference, ranging from absolutely zero tolerance to having a pre-defined minimum revenue range from the activity in question. For example, investors can invest into mutual funds or ETFs with a negative filter for these attributes; however, a common problem exists where each individual investor has their own unique values and some may be left out when investing into a pool fund (Lemke and Lins 2014).
Environmental, social, and governance (ESG) investing is another strategic subcategory under the value-based investing domain. Under the ESG approach, the emphasis is to seek and include companies based on the investor’s individual value sets rather than filtering and excluding companies with activities that are undesirable to the investor (Coleman 1988). Under the ESG approach, these factors are integrated into the whole investment process from company selection to portfolio creation and encompass both positive and negative screens. There are thousands of other factors that can be considered in each category, but the following are some of the most common types. In the environmental category, the most common factors include emission and waste, water stress, clean technologies, and climate change (Key 2015). Common social factors include health safety of employees, community relations, data privacy, and product integrity. Governance issues include executive board diversity, executive compensation, corporate structures, and business ethics (Höchstädter and Scheck 2015). Strategically, an exemplary ESG factor process would start with positive selection, where investors select from defined ESG criteria (Key 2015). This can be followed up with activism through coordinated shareholder voting of particular issues that are important to the investor’s values and beliefs. This step synergizes with engagement, where investment funds and the investor will monitor the performance of the portfolio companies to ensure they are continuing to adhere to the principles (Holland 1998). In recent years, investors as well as asset managers are relying on ESG rating agencies to measure and compare companies’ ESG adherence and performance (Huber 2017).
Impact investing is a relatively new domain of investing that incorporates many of the fundamental principles of value-based investing with an objective to create a positive and measurable impact on major environmental or social issues while achieving a market risk comparable return (Bugg-Levine 2011). Similar to value-based investing, impact investing will have a different definition for each individual investor depending on their goals and objectives. Some investors are willing to sacrifice a great deal of financial return in order to boost the environmental or social outcome impact, whereas others may only want to pursue impact investing to the extent that it yields a risk-adjusted market return for similar levels of investment (Holland 1998). Impact investors tend to be high-net-worth individuals or institutions as they have the capital and drive to pursue larger-scale social and environmental projects. These projects are highly concentrated in private markets focusing on opportunities to deliver specific outcomes (Höchstädter and Scheck 2015). Examples of these projects include microfinancing for economic development loans in developing low-income communities as well as building primary and secondary school buildings for rural villages in developing countries by an institution with an environmental and educational focus (Key 2015). Some common examples of impact opportunities can take place in the form of green bonds, equities, and development organizations that vary based on impact, financial returns, lockup liquidity period, and overall riskiness (Firzli and Nicolas 2017). The five most prevalent types of impact investing target areas are healthcare, education, infrastructure, sustainable products, and resource allocation efficiency (Berliner and Spruill 2013).
Value-Based Investing from an Institutional Perspective
Institutions, private corporations, and money managers are taking notice of the tremendous capital influx into value-based investments in the last decade. Many new investment vehicles, value-based and impact-focused investments, and other opportunities have spawned to take advantage of the change in investor tastes and preferences. $6.57 trillion of only US assets under management have incorporated ESG criteria in 2014, which is almost double the $3.47 trillion 2 years prior in 2012 (United States 2016). Institutional investors, family offices, high-net-worth individuals, as well as women and millennials in particular constitute the majority of current interest in the market (United States 2016). Research shows that Millennials tend to be more value focused as well as more environmentally conscious and aware, with 85% of millennial respondents agreeing that social and environmental impacts are an important part of their investment decision compared to 70% of Generation X and 49% of baby boomers (Key 2015).
Institutions are unique entities that are both investors and recipients of investment. As such they are often conflicted between financial return and institutional mission. The best illustration is the state university, created using public investment funding for the purpose of furthering education. The state university has its own endowment for the purpose of grants and other uses; however, they may become conflicted with a choice between high financial return that goes against furthering education and university missions (Höchstädter and Scheck 2015). As value-based investing for sustainability has become more mainstream, institutions are finding ways to incorporate ESG and social impact investments into their endowments that result in alignment of interest.
Governments and national and international public institutions have long sought to leverage their policies to become more impact oriented, and the value-based investment movement has begun to spur large pension funds and asset owners to co-invest with government entities in impact-related asset classes and projects (Firzli and Nicolas 2017). Value-based investing has become an international focus among governments and corporations. The National Government of India has made corporate social responsibility mandatory for corporation organizations making the discussion topical throughout the entire country (Shah and Ramamoorthy 2013). Similar legislation in the UK, Korea, Netherlands, Australia, and Denmark exist for compulsory environmental reporting but not for all encompassing ESG reporting. The United Nations has been very proactive in the creation and adoption of environmental and ESG accounting practices, creating the division of the United Nations Division for Sustainable Development publication Environmental Management Accounting Procedures and Principles (United Nations 2002). In 2014, the European Commission also issued new directives obligating large corporations with more than 500 employees to provide similar types of disclosures to public markets and investors (Pedersen 2015). The requirements of reporting involve environmental, social, employee-related, human rights, anti-corruption, and bribery measures as well as their diversity policy for management (Solsbach et al. 2014). As many countries transition to include value-based investment sustainability reporting objectives, frameworks such as the Global Reporting Initiative, the United Nations Global Compact (UNGC), the UN Guiding Principles on Business and Human Rights, and the OECD Guidelines are becoming more ubiquitously adopted (Brown et al. 2009).
The Global Reporting Initiative is one of the many organizations and institutions responsible for monitoring and establishing guidelines for sustainability reporting. Under increasing pressure from stakeholder groups such as investors, governments, and corporations to be more transparent about their environmental, economic, and social impacts, many companies voluntarily choose to publish a sustainability report that adheres to the recommendation and guidelines established in the Global Reporting Initiative (Pedersen 2015). The GRI framework allows third parties to assess and standardize the environmental impact of the company via its activities and supply chain such CO2 emission (Global Reporting Initiative 2015). A common criticism with GRI reporting is that it provides a greater focus on reporting, rather than actionable reporting, quantity over quality. As more companies voluntarily adhere to the GRI framework, the risk of “greenwashing” increases, where companies may falsify or exaggerate their environmental and social impacts in order to garner positive perception (Brown et al. 2009).
In corporate reporting, many corporations place oversized emphasis on eco-efficiency or the reduction of resource, energy, and waste per unit of production. This ensures that only a partial picture of a company’s footprint is transparent and typically emphasizes self-reporting on statistics that paint the company in a positive light. Thus, companies can demonstrate large improvements in eco-efficiency while not necessarily addressing their true ecological footprint.
In order to combat greenwashing and increase transparency, many institutions and corporations are voluntarily certified by third party auditors, which independently verify the claims made by self-reporting entities. Third party independent verification assures stakeholder reports are fully credible and contains audited information. Many use internationalized standards to gauge adherence and compliance such as AA1000, ISAE 3000, and GRI (Gray 2001). Independent verification auditors typically provide a detailed report that outlines the data collection process as well as provide consulting on improving existing frameworks. Thus, these independent social auditors attempt to blur the boundaries between organizations and society to establish a fluid line of communication (Gray 2001).
Value-based financial instruments and portfolios have been on the rise in the last decade. Money managers with an ESG focus go beyond the simple integration of defining filter parameters and factors in portfolio creation. They support their investor’s principles through active shareholder engagement, directly communicating with companies on behalf of shareholders and exercising their voting rights, shareholder resolutions, and other privileges (Shah and Ramamoorthy 2013). This activism has greatly boosted corporate accountability in ESG practices and has driven many investors to rely on managers using ESG factors for value alignment. ESG managers and investors assert that considering ESG factors such as environmentally responsible behavior, sustainable practices, and strong corporate responsibility results in a more comprehensive and holistic investment analysis for companies and investment opportunities (Solsbach et al. 2014). As such, money managers can either set up private equity, debt instruments to directly support an investor’s goal in the case of high-net-worth family offices or go through indirect intermediary methods by creating portfolios that proxy the range of environmental and social values of the investor. Value-based investment instruments in sustainability have further evolved to include a broad spectrum of strategies such as divestment, positive investing, community investment, as well as shareholder activism and engagement (IRRC Institute 2017). Divestment occurs in an institutional setting when money managers actively remove stocks as in the case of CaLSTRS (California State Teacher’s Retirement System) which removed $237 million from tobacco stock holdings (Gray 2015). Positive investing involves a new generation of socially responsible investing that involves a broad revamping of industry methodology for driving change through investments. This approach effectively enables investment managers to positively express the values and beliefs of their investors such as social justice and environmental issues without sacrificing portfolio diversification or long-term profit (Wine 2009). It furthers the idea of value-based investment sustainability, extending it to a company’s sustainability or potential ability to succeed in the long term. Community investment allows direct investment by institutions rather than through equity purchases, allowing money managers to directly invest in the areas that their client’s money can make a measureable impact (Wine 2009).
At present, the bodies of research covering the financial performance of value-based investments in sustainability is limited as this is a newer holistic approach to investing and a wide spectrum of return results have been documented. With no general consensus or industry standard on what constitutes “value-based investments in sustainability” and what does not, it is currently difficult to use standardized metrics for ongoing measurement of impacts. As value-based investments in sustainability become more mainstream, the positive impacts associated with its exponential growth and demand will expand academic research, increasing the amount of tools, data, and analysis available to gauge and assess the effectiveness of this new investment approach.
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