Being mindful about the impact of our money

9th Feb. 2022

At the heart of financial management is the recognition that, in general, there’s a trade-off between risk and return—generally, there’s potential to achieve higher returns by accepting higher risks.

Originally published on Sharesies, written by Barry Coates - Mindful Money's founder

At the heart of financial management is the recognition that, in general, there’s a trade-off between risk and return—generally, there’s potential to achieve higher returns by accepting higher risks. Managing investment risk, including managing the environmental, social, and governance (ESG) risks of an investment, is a core role of financial managers.

Yet, until recently, ESG risks have largely been ignored in financial decision-making. This thinking has been a major contributor to the multiple crises that we face today, including climate change, biodiversity loss, and inequality.

These risks are growing, and it’s not just because of climate change. We live on a crowded planet where our economic activities are damaging the ecosystems we depend on, and economic wealth is unequally shared. ESG risks are relevant to the financial performance of most companies—evidence from recent decades shows that lowering these risks can potentially result in financial returns that are at least as high, or higher, than ignoring them.

From managing risk to creating a positive impact

For the investors that want to have a positive impact, the challenge is to not just reduce the financial risks that ESG factors pose to investment, but also reduce the risks that investment poses to the environment and societies.

Managing ESG risks doesn’t always align with real-world impact. For example, under current approaches to ESG risk management, there’s unlikely to be any financial risk to a company if they violate human rights in a marginalised and remote community, or pollute a river (if they can get away without a fine or damage to their reputation).

There’s growing acceptance that every business (not just sustainability leaders or those signed up as B Corps) has a responsibility towards its stakeholders and broader society. Business leaders need to demonstrate a clear public purpose for their business. This is now being recognised by mainstream forums like the US Business Roundtable, and financial leaders like Larry Fink (CEO of the world’s largest asset management company, BlackRock).

A new framework for investing

An integrated framework for investing that includes impact (as well as risk and return) is needed. In fact, a growing number of investors already think in impact terms—they want to avoid investing in companies that cause harm, and would like to invest in companies that create positive benefits.

In the past, investors have had few opportunities to do so. If they invested in companies directly, they could have made a positive impact by investing in companies in sectors like wind power or health care, but it was hard to achieve diversification. If they invested in diversified funds, they could have chosen funds that avoid harm or use ESG management to raise company standards, but there have been few funds dedicated to creating positive impact.

This has changed in recent years. More impact funds are available internationally, and there’s a growing number in New Zealand. At Mindful Money, we’ve recently launched a directory of New Zealand impact funds, most of them, as yet, only available to professional or wholesale investors.

In addition, mainstream KiwiSaver and investment funds have also started to add investments in impact companies, including in sectors like renewable energy and social housing. Typically, they invest only a small proportion of their portfolio in companies dedicated to achieving positive impact, but this is starting to scale up into a significant pool of funding for sustainability and climate solutions.

Beware of ESG-wash

There’s been huge progress in responsible investing, but as demand has grown, an increasing number of funds have used greenwashing tactics. Some have been claiming to manage their funds according to ESG principles, while changing very little of their traditional practices.

One example of this is the continued investment in fossil fuels despite the many warnings about the risks of climate change, and the decline in their share prices over the past decade. The proportion of KiwiSaver funds that exclude fossil fuel producers has increased from 2% in 2019 to 19% today. While this increase is welcome, this is still a low proportion considering we’re operating in a climate emergency. Coal, oil, and gas are declining and unsustainable, and surveys show that New Zealanders want to avoid fossil fuels in their investments.

Finding objective information about funds can be difficult. Mindful Money shows which companies are in the portfolios of all KiwiSaver and retail investment funds, categorised by issues that the public want to avoid. Investors can also use resources like our Ethical Investment Guide to learn more about investing ethically to create a better outcome for people and our planet.