The right choices

  • 11th October 2023

Heather Lamont says responsible investment is about sustainability, not compromise

Ethical investment? Responsible investment? ESG? Sustainability? Impact investing? If you’ve been discussing your school’s investment policy recently, no doubt some of this jargon will have crept into the debate. But when the industry can’t even agree what to call it, never mind what it means, it’s no wonder there’s a good deal of scepticism around. Many an investment committee will be inclined to reject any reference to non-financial issues as a marketing gimmick which risks detracting from spending resources.

However, ignoring the subject isn’t really an option – at least not if you want to comply with investment guidance from the Charity Commission and other regulators. The good news is, it shouldn’t actually be that difficult to understand and agree on what’s important (and what’s not) for your school and how to express your priorities in your investment policy.

A straightforward framework for thinking about the non-financial aspects of your policy typically encompasses three distinct, but often overlapping, approaches.

The longest established and most traditional approach, as well as the easiest to implement, is what most people would historically have meant by ‘ethical investment’. It’s principally about identifying any types of business activity that you don’t want to see among the companies in your portfolio because they conflict with your school’s values or would expose you to reputational risk.

For some schools a light touch will be sufficient and appropriate here, indeed many parents and governors will be content if there are no explicit exclusions. It’s perfectly legitimate to conclude that you don’t need an ethical policy, but you should still have the conversation and record your rationale. Conversely, many investors, including most faith schools, will want their investment policy to reflect their founding ethos, and they will often be able to refer to faith-consistent investment guidance specific to their own institution or denomination for help in expressing their policy.

It’s important to work with your fund manager to understand how they will implement your intended policy. Do they have the information resource to identify and monitor which companies may fall foul of the agreed policy? What revenue thresholds can they apply when screening for excluded stocks? A typical approach is to exclude any business which generates more than a given percentage (often 10%) of its turnover from the offending activity. This works well for most themes, for example if you want to exclude tobacco companies but not supermarkets, a 10% screen for tobacco would usually do the trick. But there may be activities for which a zero tolerance is preferred; this is often the case in respect of illegal weaponry such as cluster bombs and landmines.

One common pitfall is to apply any exclusion policy only to ‘direct holdings’ in individual company names. In practice almost all schools’ portfolios are invested significantly, in many cases wholly, through pooled investment funds. If you do have exclusion criteria, you should discuss with your fund manager whether these are being applied consistently across the portfolio, and identify any reputational risk that you face if pooled funds are not screened according to the same criteria as direct holdings.

Incidentally, there’s no evidence that any reasonable screening policy need be damaging to your long-term investment returns. Over shorter time periods there can be some divergence – this can be positive as well as negative – between screened and unscreened portfolios, but these variances tend to even each other out over time. In any case, the regulator is clear that charity trustees should at least consider whether any screening is appropriate for their organisation, not just dismiss the idea out of hand.

This is a key element of responsible investment management. Your fund manager should assess the risks to your portfolio associated with the environmental, social and governance (ESG) standards of investee companies and potential holdings. Unlike the ‘alignment’ approach above, this isn’t about what business they’re in, but rather about how they do business.

Good fund managers will address these issues as an integral part of their investment process, because this assessment is about enhancing the sustainability of your portfolio returns. However attractive they may look through the lens of conventional financial analysis, companies which have poor standards of behaviour tend to underperform over the long term. They are also more prone to financial shocks and sudden reputational damage which can destroy shareholder value. So your investment policy should recognise the importance of ESG considerations and your fund manager should be happy to discuss how they incorporate these in decision-making.

Schools and other charitable investors are increasingly aware that investment markets and portfolios can only be as healthy as the environment and communities in which they operate. For many, therefore, the long-term sustainability of returns requires real- world change to help address systemic challenges like climate change, modern slavery and health crises such as soaring global rates of obesity and poor mental health.

A number of industry-led initiatives have already demonstrated that commitment and collaboration by investment managers who engage with companies and regulators on behalf of the investment community can indeed drive change in company behaviour over time.

In practical terms, driving improvements in behaviour across the corporate sector has much more impact on the issues of concern than any policy on what sort of companies are or are not permitted in a school’s portfolio. Most investment decisions simply involve your school buying assets from other investors or selling to them. These transactions don’t change the amount of capital that is allocated to the activities in question, whether ‘bad’ or ‘good’. Even policies which aspire to include ‘positive’ investments in the portfolio tend to have very limited real-world impact.

So another question for your fund manager should be around their commitment to driving real change on these systemic issues, and what impact they are having.

Which of these approaches – it could be one, two or all three of them – is relevant to your school? That’s the conversation you should be having, if you haven’t already. It doesn’t even matter what you call it. The important thing is to get past the jargon, consider what matters to your school and understand how your fund manager can support those objectives – and then hold them to account for delivering against what you’ve agreed.

Heather Lamont is a client investments director at investment company CCLA.

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