Given the complexities in assessing sustainable factors as part of allocation decisions, investors need to take a more diverse approach rather than simply divest from perceived ‘bad’ companies, according to Kristina Church (pictured), head of responsible strategy at BNY Mellon Investment Management (BNY Mellon IM).

She said investing in companies that are actively transitioning to more environmentally-friendly and socially-acceptable business models can deliver “greater change to the wider environment and society than investing in entities already aligned to low-carbon or socially responsible models” and therefore should not be excluded.

Furthermore, stewardship can play a key role in driving more consistency and quality in ESG data and determining the success – or not – of each transition model, she added.

“Even the most sustainable investments can include companies which might today be scoring less well on the criteria checklist for investments that claim to have ESG-friendly status,” Church noted as she explained how responsible investment is a spectrum of investing styles.

Engaging with critical industries to impact change ensures these businesses don’t get starved of the capital they need to achieve their own ESG objectives, she added.

Multi-pronged engagement

Church also urged investors to not rely only on external providers of ESG data and static scoring systems as the likely outcome would be a limited range of best-in-class or ‘ESG champion’ investments, potentially missing opportunities outside this classification.

“[This] not only creates the risk of ‘overcrowding’ in favoured stocks and sectors but also risks directing flows away from sectors which are vital for future economic growth and most desperately need investment to achieve the necessary transitions,” said Church.

Using climate as an example, without financing the transition of ‘dirty’ carbon-intensive industries such as cement, heavy-duty transport, steel and chemicals, net zero will be impossible to reach.

“Forward-looking investment management firms are beginning to move away from simply making low-carbon investments to investing in companies that are engaged in this wholescale clean-energy transition to address either climate mitigation or climate adaptation,” explained Church.

At the same time, to be investable, companies in carbon-intensive sectors need to have credible, public strategies to transition in line with the goals of the Paris Agreement, plus need to report their greenhouse gas emissions in line with recognised standards.

Investors also need to be able to track how success is measured and set limits that might eventually drive divestment if the criteria are not met.

Further, investors need to consider where a company is based and the associated pathway to net zero, rather than treating every investment option in a uniform way.

Similarly, with social issues rising up the investment agenda, progress on diversity, equity and inclusion (DEI) is increasingly becoming a differentiator for companies – for example, in terms of the impact on their ability to attract top talent, raise capital and reflect the profile of their customers, Church commented

Yet without access to consistent data to analyse DEI factors, the key for investors is to engage with companies to try to fill the gaps, as well as focus on those companies that are delivering improvements on specific DEI credentials, she added.

A version of this article first appeared on ESG Clarity‘s sister title Fund Selector Asia.