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How does SRI work?

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By Capital Partners Markets and Investments

Just as everyone’s values differ, so too do the way investment managers approach socially responsible investing (SRI), otherwise known as sustainable investing. Investment managers can use one of the following three strategies to guide their investment choices: a passive, integration or an active approach.

Passive approach

A passive SRI approach considers how a company’s SRI performance affects the company’s value, risk profile and financial returns. Investment managers take SRI into account, but only as a secondary factor.

Institutional investors, like super funds or large fund managers, may also use their shareholder power to prompt positive changes in a company. For example, to divest from fossil fuels, commit to improving workers’ conditions, or disclose the risks that climate change has on their business.

While this action can help improve a company’s social, environmental or governance profile, its main aim is to improve its financial returns, or to reduce risks that could impact its share price.

A passive approach usually has minimal impacts – either positive or negative – on a portfolio’s returns. However, it’s also relatively ineffective in creating significant social or environmental change.

Integration approach

The integration approach treats a company’s SRI profile and its potential for financial returns as equally important. The investment manager uses data from third-party research entities, like US financial company MSCI, to help inform their investment decision-making process.

Here’s how it works: MSCI uses a rating system to measure companies, against their peers, based on how well they manage their exposure to ESG risks. The investment manager can then use these ratings to select investments, and then rebalance their portfolio, so it is weighted toward companies with higher SRI scores.

An integration approach doesn’t just screen out companies with poor ESG scores. It’s also possible to use positive screens to identify companies making gains in the right direction. The best performers in a polluting industry may be those leading the transition to a greener future.

Impact approach

With an impact approach, the investment manager places a company’s SRI impact above its financial returns. The investment manager actively searches for investments that have a positive impact on the environment and society, like renewable energy or social enterprises – and screens out those with negative impacts, like tobacco or weapons.

Because this approach places less emphasis on maximising profitability and returns, portfolios based on the active approach often have a higher level of volatility. However, they generally achieve more positive social and environmental impacts.

The information provided on this site is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different and you should seek advice from a financial planner who can consider if these strategies and products are right for you.

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