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New Definitions Proposed for Responsible Investing

CFA Institute-led group seeks to provide verbiage for investors that promotes unifying around common, accurate and consistent definitions for responsible investment practices. 

By Remy Samuels




In an effort to standardize terminology and enable institutional investors, regulators and industry participants to communicate with precision about environmental, social and governance investing and other responsible investing terminology, the CFA Institute recently published new definitions for sustainable finance-related terms. 

Margaret Franklin, CEO and president of the CFA Institute, said that this project is “critical to ensure that professionals can communicate efficiently and effectively with each other, as well as investors and industry professionals across the market.”

The definitions report was published as legal challenges continue to the Department of Labor’s rule permitting the consideration of ESG factors when selecting investments for defined contribution retirement plans, along with other conflicts at the state and federal over the role ESG in the proxy voting process and other systems.

The CFA Institute collaborated with the Global Sustainable Investment Alliance and the Principles for Responsible Investment to harmonize definitions for the following responsible investment terms:

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  • Screening
  • ESG integration
  • Thematic investing 
  • Stewardship
  • Impact investing

Chris Fedler, head of industry codes and standards at the CFA, said in an emailed response to questions that well-defined terminology is essential for clear communication.

“Unclear and inconsistent terminology can cause confusion in the marketplace, making it harder for both clients and investment managers to achieve their goals,” Fedler said.

For this project, Fedler said the CFA selected commonly used terms that needed additional clarity and consistency.

“We focused our efforts solely on terms associated with responsible investment approaches, but these are not the only sort of terms that cause confusion,” Fedler said. “Greenwashing, for example, is a frequently used term that does not have a precise and consistent definition.”

Screening

Screening is the process for determining which investments are or are not permitted in a portfolio. According to the CFA, this process is used for attaining an investment focus, complying with laws and regulations, satisfying investor preferences and limiting risk.

The new definition for screening is “applying rules based on defined criteria that determine whether an investment is permissible.” The defined criteria can be qualitative or quantitative. 

For example, criteria can be whether the issuer or security in question is a constituent of a specific ESG-related index or whether a sovereign issuer achieves a given human rights performance score from a specific ratings provider.

The CFA argued that if rules are not based on defined criteria and applied consistently, the activity should not be characterized as screening.

ESG Integration

ESG integration should be defined as the ongoing consideration of ESG factors within an investment analysis and decision-making process with the aim to improve risk-adjusted returns, according to the CFA. 

This integration involves identifying and assessing the ESG risks and opportunities that are relevant to investments, weighing that information and making decisions about those investments. The CFA argued that this is an ongoing part of the investment process—not a one-time activity.

Consideration of ESG factors, however, does not imply that there are restrictions on the investment universe and that ESG factors are given more or less consideration than other types of factors.

“When communicating to general rather than professional audiences, investors should avoid the term ‘ESG integration’ and instead use plain language to accurately describe how ESG factors are considered in the investment process,” the CFA recommended in its report.

Thematic Investing

Thematic investing, according to the CFA, involves selecting assets to access specified trends.

“Thematic investing is underpinned by the belief that economic, technological, demographic, cultural, political, environmental, social, and regulatory dynamics are key drivers of investment risk and return,” the report stated.

This term essentially refers to selecting companies chosen in a top-down process for inclusion in an investment portfolio that fall under a sustainability-related theme, such as clean technology, sustainable agriculture, health care or climate change mitigation. 

The CFA noted that thematic investing differs from constructing a portfolio with a particular focus. For example, investors may wish to invest in a portfolio of a veteran-owned business because they want to support veterans while earning a financial return, but this would not be considered “thematic investing” unless a case was made for how veteran-owned business enable access to a specified trend or trends.

“Thematic investing often—but not always—results in a focused portfolio, but not all focused portfolios are the result of thematic investing,” according to the report.

Stewardship

In the context of ESG, stewardship refers to “deliberate deployment of rights and influence (beyond capital allocation) to protect and advance the interests of those clients and beneficiaries.” This includes the common economic, social and environmental assets on which their interests depend.

Some examples of ways in which investors can exercise their rights and influence include serving on or nominating directors to a company’s board, filing shareholder resolutions or statements and voting on proposals at shareholder meetings.

The CFA argued that the term stewardship should not be used to refer to activities like proxy voting and engagement unless these actions are “undertaken to protect and enhance overall value for clients and beneficiaries.”

Impact Investing

Lastly, the CFA defined impact investing as investing with the intention to generate positive, measurable social and/or environmental impact alongside a financial return. 

Impact investing can be pursued across a range of asset classes, including fixed income, real assets, private equity and listed equity investments, according to the CFA. 

This concept differs from philanthropy in that it pursues a financial return in addition to a positive, measurable impact. Impact investors have discretion over the rate of return they target.

Wilshire Advisors LLC also recently released a report arguing that while ESG stands for environmental, social and governance, “its meaning differs from individual to individual and from organization to organization.” 

The Wilshire report argued that ESG investing is too often viewed monolithically deemed either “good” or “bad.”

“Ultimately, considering all ESG ‘good’ or all ESG ‘bad’ is not prudent,” the Wilshire report stated. “This binary view fails to acknowledge the nuances of ESG investing. Like any investment, the product, people and process matter. Furthermore, this view of ESG limits the ability to see that folks on either side of the debate have a lot more common ground than the headlines and rhetoric would suggest.”

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Home > News > Asset Allocation > An EM Rebound—and It’s Not All About China
Asset Allocation

An EM Rebound—and It’s Not All About China

Why emerging markets, now in the doldrums, will come back, per Lazard.

By Larry Light




Emerging market stock indexes have suffered, largely due to China’s economic stumbles related to its pandemic lockdown and the aftermath. China makes up 30% of the main exchange-traded fund tracking the EM space, iShares MSCI Emerging Markets. And the country’s thirst for EM raw materials extends its influence globally. But even leaving out China, many EM stocks have been disappointing in 2023.

The Shanghai Composite is down almost 18% from its highs at the end of 2021 and 2% this year, amid weakened corporate earnings growth and heavy debt burdens. Thus far in 2023, the MSCI Emerging Markets index is barely in the black, up 1.5%. But take out China, and the index is further ahead, up 7.5%. That’s still underwhelming: the S&P 500, reflecting the ongoing strength of the U.S. economy, has jumped 13.5%

But there’s some good news for EM investors ahead, according to Lazard Asset Management. The firm’s report declared that renewed stimulus from Beijing stands to perk up China economically—and its shares. Even better, the Lazard report explained, many other EM nations have the ingredients to power ahead next year, independent of China’s trajectory.

The latest rescue plan from the Chinese government, Lazard wrote, should be a tonic, as it has been in the past: “For the country’s troubled real estate sector, down payment requirements for mortgages have been reduced, while banks have been encouraged to lower interest rates.”

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Moreover, earnings in China and other EM nations are looking better up ahead. Non-China EM businesses in many cases don’t carry big debt burdens and tend to have a lot of cash, Lazard researchers and other strategists maintain. In 2024, the Lazard report noted, EM companies are projected to post an average 19% earnings growth, compared with 10% for the U.S., per FactSet Research.

In Asia, outside of China, and in Latin America, escalating interest rates are not much of a problem, says Alia Yousuf, CEO of Singapore-based Global Evolution, an EM-oriented subsidiary of asset manager Conning Holdings Ltd. “In Asia, they were the last ones to hike due to low inflation,” she pointed out. In Latin America, where inflation has been high, a lot of central-bank tightening already has occurred to combat spiraling prices, she adds.

Other “big drivers” to watch out for, she says, are the Federal Reserve’s monetary policy and U.S. Treasury bonds’ behavior. How these two forces fare affects the now-strong U.S. dollar, which is a potent influence in international trade.

 The health of EM investments is important to allocators in the U.S. and the West. The New Jersey Division of Investment, for instance, had 4.9% of its portfolio in EM equities, as of June 2023—shy of its long-time target of 5.5%, because the plan wanted to keep a defensive posture amid market volatility.

Right now, EM stocks are pretty cheap, Lazard observes. Their valuations are 30% below those of developed market stocks and 35% below U.S. equities, the firm stated.

Economic trends are very encouraging for many EM economies and shares, in Lazard’s view. “Emerging markets’ economic growth is now starting to move higher as developed markets’ growth slows, and emerging markets are being driven by more than just China,” Lazard wrote.

India, for example, has a demographic tailwind, with 80% of its population younger than 50. In Latin America, mainly Brazil and Mexico, in-migration of manufacturers from China to be closer to the U.S., a phenomenon known as “nearshoring,” will be a big boon, Lazard contended.

Opportunities also abound in EM debt. Often, EM bonds are attractive because they sport higher yields than U.S. paper: on average around 9% for emerging market sovereign debt, per Bloomberg statistics. India’s 10-year government bond yields 7.3%. Global Evolution’s Yousuf recommends high-yield EM corporates, as they pay even more than EM sovereign debt.

Overall, she went on, given the range of EM capabilities—from Latin America’s commodities to Asia’s technology—emerging nations represent “a good, diversified asset class.”

Related Stories:

Institutional Investors Take a Cautious, Long-Term Approach to Emerging Markets

Emerging Markets Remain Under Pressure

Where to Find the Best Emerging Markets Returns

 

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