It took three centuries for the practice of making investments in privately held companies to gain a term of its own in the mid-1940s: “private equity.” Venture capital and hedge funds were originally known as “development capital” and “hedged funds” when they first came to light. The term “family office” still lacks today a universal definition, over one hundred years since they were first established in the United States.
Finance terminology is often shaped organically in pushing and shoving exercises amongst financial houses, rather than in a disciplined way of universally coining new investment practices and disciplines.
The field of sustainable finance is a forest…
This incertitude applies to sustainable finance too. Investors have been making sustainable investments since the 18th century, but it was the boom in the last few years that triggered an unexpected side effect: an alphabet soup of different, inconsistent, and confusing terms and definitions.
Terms such as “responsible investing”, “impact investing”, “ESG investing,” “sustainable investing”, to name just a few, are used freely with no clear conceptual demarcation nor universal understanding of what they actually mean. The muddle of terms is jeopardizing wealth managers’ counselling quality, tainting research and global statistics on the sustainable finance industry, hindering the launch of new products and solutions, and opening up opportunities for the deceptive use of those terms. Lack of universality hinders mainstreaming.
This concern has been raised by asset owners and asset managers. A recent AON study showed that 25% of investor organizations don’t engage in responsible investing because there is a lack of agreement on key issues such as terminology. In an op-ed in the Financial Times, Axel Weber, chairman of UBS, wrote that the “sustainable and impact investments industry needs to agree, simplify and standardise its terms and products. The sector must come up with common definitions for sustainable investment.”
To overcome this major roadblock in the industry, the Granito Group has assessed and compared definitions from a very large number of sources. The result is the Impact Economy Glossary, an attempt to simplify and standardize terms and practices.
The field of sustainable finance is a forest with three main and broad groups of investment approaches: “sustainable investing,” “screening,” and “impact investing.”
“Sustainable Investing” or “Responsible Investing” is about bringing additional data and analysis into financial decision-making. This supplementary data is a set of environmental, social and corporate governance (ESG) information that adds up an additional layer of information to the more traditional quantitative and qualitative “fundamental analysis” of assets. It is about replacing X-rays with magnetic resonance imaging or about increasing the magnifying power of asset managers.
Sustainable investing, which indeed aims to better manage risk and generate higher returns, can be applied to all assets. If you wish to invest in equities, then companies with superior ESG performance can be found in all industries, including coal, oil & gas, tobacco, alcoholic beverages, or mining. If an investor has no social or environmental inclinations, sustainable investing is still a viable option.
The UN-supported Principles for Responsible Investment (PRI), a network that includes the largest institutional investors, makes clear that “responsible investment can and should be pursued even by the investor whose sole purpose is financial return, because it argues that to ignore ESG factors is to ignore risks and opportunities that have a material effect on the returns delivered to clients and beneficiaries.”
The second group is called “Screening” (aka as “Socially-Conscious Investing”, “Social Investing,” “Socially Responsible Investing” (SRI), or “ESG Investing”) and refers to the active exclusion or inclusion of certain sectors, countries, and securities from an investment universe based on specific ESG-related criteria.
Screening has many subtypes. “Positive Screening” is about selecting companies or projects according to their ESG performance relative to industry peers (i.e. companies within the same sector or projects within the same category) based on a sustainability rating, whereas “Negative Screening” excludes from a fund or portfolio certain sectors, countries, companies or practices based on specific ESG criteria.
Exclusion criteria may include product categories (e.g. weapons, tobacco, alcohol), corporate activities (e.g. animal testing), business practices (e.g. violation of human rights, corruption, pollution), personal or moral values (e.g. gambling), countries (e.g. dictatorships) or risk considerations (e.g. nuclear power).
The term “impact investing” was actually coined in 2007
Other subtypes include Norms-Based Screening, Ethical Investing, Thematic Investing or Mission-Aligned Investing. All relate to different filters applied to portfolios.
The third group is known as “Impact Investing” and is about investments made into companies, organizations, and funds with the intention to generate both financial return and positive social and/or environmental impacts that are actively measured. Intentionality of impact and measurement of impact are two of the requirements for an investment to be labelled as an “impact investment.”
While the sustainable finance market manages $23 trillion in AUM, impact investments made up only $ 228 billion of that, or 1%. But it is growing quickly as financial powerhouses like TPG are putting large impact investing products in the market. TPG’s $2.1 billion-Rise Fund is trending at 25% IRR and fundraising for the second fund targetingS$3.5 billion have begun.
The term “impact investing” was actually coined in 2007 when a group of investors hosted by the Rockefeller Foundation met to discuss a new form of financial investment that could achieve a social or environmental impact. But although the label was born with clear boundaries, it is still sometimes hijacked to inaccurately describe the whole sustainable finance industry.
We lack, in fact, people in the finance industry who could be inspired by Jacob and Wilhelm Grimm, the brothers who spent part of their lives in the 19th century painstakingly creating the largest and most comprehensive dictionary of the German language in existence. Still, financial markets are made up of people guided by logic and rationality. And hopefully, everyone will soon realize that using sustainable finance terms consistently is actually good business.
Rodrigo Tavares is founder and president of the Granito Group, a company that advances the sustainable economy through management consulting, financial advisory, and policy & research. He was nominated Young Global Leader by the World Economic Forum (2017).