5 Challenges for Socially Responsible Investing: BNY Mellon

While socially responsible investing is gaining traction among investors, several challenges remain to unlocking its full potential

In the United States alone, the total value of professionally managed assets integrating socially responsible investing considerations expanded to nearly $7 trillion at the start of 2014, from just under $4 trillion at the start of 2012.

While socially responsible investing, or “social finance” as BNY Mellon calls it, is gaining traction among investors, there are still several challenges to unlocking its full potential.

BNY Mellon released a report “Social Finance at Scale: Creating Value for Investors” addressing the challenges facing socially responsible investing.

BNY Mellon points to research that shows just how large the need is for social finance. BNY Mellon’s definition of “social finance” – more broad than what is traditionally considered SRI – refers to any investment activity that generates financial returns and includes social or environmental impact.

“The annual global investment needed in developing countries in key sectors related to the proposed UN Sustainable Development Goals is estimated to range from US$3.3 trillion to US$4.5 trillion,” the report states. “Current investment in these sectors is around US$1.4 trillion, leaving an investment gap of between US$1.9 and US$3.1 trillion per year.”

Charles P. Dolan, the chief investment strategist for fixed income, cash and currency at BNY Mellon Investment Management, and BNY Mellon believes there needs to be a greater effort industry-wide to motivate the investment community and engage clients.

“When we look at the research, we see … trillions of dollars needed to address various problems,” said Dolan, in an interview with ThinkAdvisor. “We and others feel there’s just not enough of public sector money or philanthropy to meet these needs.”

To determine the challenges facing social finance, BNY Mellon looked at its own insights, sponsored research conducted by Business for Social Responsibility, and had conversations with dozens of mainstream and social finance investors.

“What we also did was we went and we talked to investors and said, what is it that’s potentially keeping you from doing more in this area?” Dolan told ThinkAdvisor.

And from there, BNY Mellon proposed five challenges that need to be addressed to bring social finance to scale.

“I feel quite strongly that this is something that we need to do,” Dolan told ThinkAdvisor. Adding, “We identified [a number of] specific things that we feel quite strongly are not only things people can do but can evidence that they are doing. Some of these overlap with the U.N. Principles of Responsible Investing, but what we believe are more specific and targeted on things that we believe will change the [social finance] landscape the most.”

Here are the five challenges facing the social finance industry:

1: Accessibility

Investors don’t have access to attractive social finance investment products that meet both the investor risk and return requirements. BNY Mellon says that some social finance products have longer durations and maturities leading to higher risk, and limited or no liquidity.

According to BNY Mellon, an insufficient supply of scalable products that offer attractive risk-adjusted returns creates a bottleneck.

BNY Mellon suggests three solutions:

  • Facilitate asset allocation with multiple social finance products which meet different risk tolerances, return expectations and liquidity requirements
  • Create products with well-defined return expectations and clear impact objectives
  • Deepen social finance expertise and knowledge in investment teams and among client advisors

2: Measurement

As a relatively new field, track records for social finance are still developing – as are the benchmarks, metrics, and rating systems that allow investors to assess these opportunities. Building track records, frameworks, and presentation standards are necessary to generate investor confidence.

BNY Mellon suggests two solutions:

  • Develop and adopt standardized nonfinancial metrics
  • Integrate social and environmental impact into valuation and risk measurement

3: Transparency

Non-traditional language, multiple terms and definitions, and unclear value propositions have deterred some investors from exploring social finance.

BNY Mellon suggests two solutions:

  • Drive consistent and material disclosure of social and environmental impacts on financial performance, as well as the effect on stakeholders
  • Increase awareness and promote learning by sharing best practices regarding the integration of social finance into portfolios

4: Systemic change

According to BNY Mellon, current incentives don’t prioritize long-term impact or measurement of long-term social and environmental performance. Instead,incentive structures and benchmarks that asset owners use for evaluating asset managers are heavily weighted toward short-term and quarterly performance.

“This fails to take into account the longer time frames over which social and environmental impacts may play out,” the report states.

BNY Mellon suggests three solutions:

  • Work towards acceptance of assessment of ESG risks and opportunities as part of fiduciary duty
  • Work towards alignment of internal and external incentives with long-term value
  • Encourage good governance and positive policy that can respond to and support broader uptake of social finance

5: Collaboration

BNY Mellon believes that collaboration will be a key ingredient to the overall success of growing social finance.

“We think a collaboration in this area is important,” Dolan told ThinkAdvisor.

BNY Mellon suggests two solutions:

  • Encourage partnership among stakeholders and product innovation to control ESG risk in asset portfolios
  • Provide guidance and technical assistance to issuers in order to strengthen the pipeline of investable social finance-oriented securities

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