Top Tips for understanding SRI and risk

  • Having a sound grasp of environmental, social and governance issues is increasingly important for both investee companies and fund managers because regulation and legislation are driving standards higher. People are also increasingly interested in these issues, which is increasing demand for products and services.
  • Most ‘mainstream’ fund managers’ do not research environmental, social and governance (ESG) issues in detail. As a result, they can miss possible investment opportunities – or risks for the companies they invest in. This is particularly true for longer term issues, but can also relate to the shorter term.
  • SRI funds often dedicate significant resource to understanding ESG issues and how it may affect the companies they invest in. This can help fund managers to identify and manage opportunities as well as risks. SRI fund managers may also transfer this knowledge to other funds managed by their group.
  • Companies that manage ESG issues well relative to their peers will increasingly be at an advantage (all other things being equal).
  • Fund managers that understand ESG issues and integrate them into their investment analysis are likely to benefit (all other aspects being equal) as they will be able to spot related business opportunities (and risks) ahead of their peers.
  • Funds that invest in environmental solutions companies are investing early into companies that may enjoy significant future growth.
  • Funds that engage with the companies they invest in in order to encourage positive changes are helping those companies to identify opportunities and manage risk ahead of other companies. If managed well this can bring benefits to shareholders.
  • Screened and themed SRI funds can offer individual investors the opportunity to invest in companies with higher environmental, social, ethical and governance standards that are minimising ESG risk and making the most of the opportunities presented by such companies. This can counterbalance the potential downside of investing in a more restrictive universe.
  • Companies that manage their use of natural resources well – including the cost of carbon emissions – can save money and generate higher profits for distribution to investors.
  • Strong management of ESG issues is often regarded as an indicator of good overall company management.
  • Fund performance in SRI funds is driven as much by generic factors as stock selection decisions. Fund manager skill, market sentiment, timing, product and fund charges should not be ignored.
  • Small/mid cap bias. Some SRI options (e.g. Clean Technology and Traditional Ethical funds) are likely to have a greater proportion of their assets invested into small and mid cap investments than other ‘average’ funds. This varies significantly between funds however – and it is important not to assume this is always the case. Different strategies will suit different investors.
  • In the long term the risk of ignoring major ESG issues may be greater than the risk of focus on them. Time will tell.

Additional information

This information is to be used in conjunction with regular investment analysis.

Example issues that can impact shareholder value:

  • Environmental: climate change, use of natural resources, pollution
  • Social: health and safety, relationships with suppliers, equal opportunities
  • Governance: executive remuneration, bribery, corruption