Sustainable and Impact Investing: A Taxonomy of Approaches and Considerations for Fiduciaries

Abstract

The application of sustainable and impact investing approaches to the management of investment portfolios has risen dramatically over the past three years due to a convergence of factors, including increased cross-generational interest and the enhanced ability of asset managers to utilize these approaches when seeking strong risk-adjusted returns. But two key challenges hold many asset owners and managers back from taking action: 1) confusion over the differences among the vast array of sustainable and impact investing disciplines and 2) lack of clarity on whether and how investors who serve in a fiduciary capacity can incorporate these disciplines. In this article, the authors introduce a taxonomy of sustainable and impact investing approaches, mapped to a set of guidelines for fiduciaries to consider in practice. This framework, based on a mix of market, legal, academic, and internal risk/return research, provides investors with guidance on applicability by ESG approach by account type, ranging from investment management accounts (both nondiscretionary and discretionary) to revocable and irrevocable trusts, to ERISA accounts. The sustainable and impact investing industry is at an inflection point where further growth will need to be supported by clear and well-supported frameworks—and this article serves to provide them.

TOPICS: ESG investing, foundations & endowments, portfolio construction, performance measurement

Key Findings

• ▪ Despite significant growth in interest and inflows over the past three years, sustainable and impact investing has reached an inflection point where the industry is being held back by a lack of clarity on definitions and fiduciary applicability.

• ▪ Sustainable and impact investing can be split into four distinct approaches: ESG integration, ESG mandated, thematic, and high impact concessionary.

• ▪ A strong fiduciary framework with limits for the application within each approach should be guided by a focus on rigorous risk-adjusted return analysis, clear documentation, and checks and balances on implementation and ongoing monitoring. The authors offer a framework to align different types of ESG investments with various investment and fiduciary mandates.