4 Steps to Sustainable Investing

For institutional asset owners, the case for incorporating sustainable investing into portfolio management is only getting stronger. As the wide-ranging implications of sustainability issues, such as public health, climate change and social justice, become more apparent, so too have they become essential to effectively assessing investment risks and opportunities.

Helping to make the case is evidence showing that incorporating environmental, social and governance (ESG) factors in portfolios could aid investors in capturing above-market returns. While the coronavirus pandemic induced a global recession and market volatility in the first half of 2020, sustainable funds—across stocks and bonds—in general helped investors weather the period better than many of their traditional peers,* according to a recent study by the Morgan Stanley Institute for Sustainable Investing. During a longer time horizon, from 2004 to 2018, sustainable funds experienced 20% less downside risk compared with traditional funds,* according to another Institute report, and 4-in-5 asset owners agree that sustainable investing may be an effective risk-management strategy and lead to higher profitability. In addition to financial performance, asset owners see an opportunity to target positive social and environmental impact, avoid reputational risk and comply with regulations.

Nevertheless, building a robust sustainable investing strategy remains an obstacle for many asset owners. Some struggle with insufficient resources and data to operationalize a broad-ranging and ambitious strategy, while others are under pressure to respond quickly to the interests of stakeholders, such as employees, regulators or peers, which risks a patchwork approach that lacks cohesion and potential internal misalignment or reputational harm.

Based on experience working with diverse asset owners, the Morgan Stanley Institute for Sustainable Investing and Morgan Stanley Investment Managementdeveloped a four-part framework tailored to help asset owners develop, implement and maintain a dynamic sustainable investing strategy.

1. Clarify Your Motivations and Investment Philosophy

Organizations should first define the reasons why they want to integrate sustainability factors into their investment processes. All key internal stakeholders, including senior leadership and investment teams, should be engaged in defining the investment philosophy.

In additional to seeking financial performance, one common motivator comes from asset owners’ constituents, such as retirees seeking to mitigate ESG risks, millennials looking to achieve positive impact through their capital, or regulators requiring greater disclosure and transparency. These stakeholders are often pushing asset owners to demonstrate the ethical, environmental and social attributes of their investments.

2. Identify Your Implementation Approaches

Next, investors can choose the approaches that best reflect their investment philosophy. There are five primary approaches and tools, commonly used in combination with one another:

• Restriction screening: Avoiding investments in certain sectors or specific issuers, based on values or risk-based criteria.
• ESG integration: Considering ESG criteria alongside financial analysis to identify risks and opportunities throughout the investment process, which may lead to decisions to avoid, include or size certain investments.
• Thematic investments: Investing focused on certain themes and sectors positioned to solve global sustainability-related challenges.
• Impact investing: Allocating to funds or enterprises structured to deliver a specific and measurable set of positive social and/or environmental impacts alongside market-rate financial returns.
• Company/issuer engagement: Aiming to drive improvement in ESG activities or outcomes through proxy voting or active dialogue with invested companies/issuers.

Representing a dynamic implementation toolkit, these approaches enable asset owners to tailor their sustainable investing activities by asset class and adjust underlying criteria over time. 

3. Define Your Investment Strategy

With an understanding of the different implementation approaches, asset owners can consider how to apply the approaches described above in their investments and define a time horizon for integrating sustainable investing more broadly across portfolios.

Institutions may opt to first introduce sustainability considerations when existing investment mandates roll over or there’s new cash to invest. They might also consider a dedicated strategy consisting of one or multiple asset classes that mirror the overall asset allocation, which can help build proof-of-concept internally. For example, a dedicated strategy focused on fixed income may seek to explore allocations toward green, social and sustainable bonds.

Achieving total portfolio integration across asset classes and investment teams may require implementation and refinement over many years, as well as a supporting operational and governance approach. 

4. Design Your Operational Model

Appropriate governance forms the operational backbone for supporting implementation and for defining, communicating and meeting sustainable investing goals. A typical governance model involves an oversight group comprising any, or all, of these roles: Chief Executive, Chief Investment Officer, Investment Committee, Risk Committee and Board of Directors, often supported by dedicated specialists.

A set of formalized and documented sustainable investing goals—including the use of an annual sustainability report or website—can also help align key stakeholders. Beyond governance and communication, asset owners must identify the needed resources—employees, skillsets, data and tools—to support a dynamic sustainable investing strategy for the long term.

For more guidelines on crafting a dynamic sustainable investing strategy, see the full report.

* This is provided for illustrative purposes only and is not meant to depict the performance of a specific investment. Past performance is no guarantee of future results. See link for more details.

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