What does it mean to invest 'ethically' or with 'impact'?

LONDON (Reuters) – Demand for funds which cherry pick investments with strong environmental, social or governance (ESG) credentials has surged in recent years.

Many of these funds include terms such as ‘ethical’ or ‘impact’ in their names. But what do these words actually mean?

Below is a glossary of the key terms often used to describe investment styles and processes.

SUSTAINABLE/RESPONSIBLE INVESTING

In the absence of a global consensus, the two are often used to describe a range of investment approaches used by fund managers to assess ESG issues before choosing to buy or sell an asset. This could mean looking at a company’s climate change preparations, its record on deforestation or its boardroom diversity to ensure it is operating in a way that is socially and environmentally sustainable over time. It also covers the way in which the asset is then managed, for example in the way the fund looks to influence company management on topics of concern.

ESG INTEGRATION

The most commonly used process, including across funds with no specific sustainability objective, ESG integration is where ESG-related factors are systematically considered as part of the investment analysis conducted by a fund manager as a way to better manage risk and returns.

ETHICAL INVESTING

One of several strategies that explicitly exclude certain stocks or sectors. Commonly used in funds which avoid the so-called ‘sin’ stocks such as companies tied to pornography, weapons, gambling, alcohol or tobacco, ethical investment funds allow an individual to invest in line with their environmental, religious or political values.

IMPACT INVESTING

While all forms of investing in theory have ‘impact’, for good or ill, funds which carry the label look to ensure the positive impact is measurable. For example, by investing in projects where the financial return is linked to improving literacy rates or health outcomes in the developing world.

BEST-IN-CLASS

As the name suggests, this approach picks companies that perform strongest on ESG-related issues, even if the sector is one that many would consider less sustainable, such as Oil and Gas. Unlike ‘ethical’ investing, which could see investors miss out completely if the sector they eschew surges in value, best-in-class investing allows funds to retain the option of exposure to the sector’s returns.

POSITIVE TILT

Often used in index-tracking funds, a ‘positive tilt’ approach would see a fund buy more of the stock of companies in a given index with a good ESG performance, for example on carbon emissions, and less of those with a worse performance.

ENGAGEMENT

Stewardship refers to the responsibility of a fund manager to manage their clients’ money in a way that creates long-term, sustainable value. One way they do this is by ‘engaging’, or talking to, the boards of the companies in which they invest to challenge them to perform better on ESG issues.

PROXY VOTING

When words are not enough, fund managers can turn to the ballot box. Specifically, anyone who owns shares in a company has the right to vote once a year on a range of issues including whether or not to confirm the board in their jobs, and to support their proposed pay and bonus plans. In a mutual fund, where many thousands of people may share ownership, the fund manager or the fund management company running the fund decides which way to vote on their behalf.

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