Introduction to Sustainable Investing
November 14, 2023
Introduction to Sustainable Investing
November 14, 2023
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Is investing in funds or stocks in alignment with your principles and beliefs important to you? If so, understanding what sustainable investing is and how you can make it work for you is the first step to making the move to more sustainable and socially responsible options.
Sustainable investing is on the rise, but what is it and how do you know if it’s right for you? Morningstar reports that green funds have reached all-time highs in terms of fund flows throughout 2020 and into the first quarter of 2021. Q1 2021 saw $21.5 billion in net inflows into sustainable funds—and it’s likely to continue to rise as people seek out ways to make an impact socially and environmentally with a similar rate of return as traditional funds with the added benefit of lower risk. In fact, according to Morningstar’s 2021 Sustainable Funds U.S. Landscape Report, sustainable funds outperformed their traditional fund counterparts on average. According to US SIF Foundation’s 2020 Report on US Sustainable and Impact Investing Trends, “$17.1 trillion in total assets under management at the end of 2019” used sustainable investing strategies, which represents a 42% increase from the number identified two years before. One in three dollars under professional management is invested using sustainable practices.
With this in mind, many companies are disclosing more information to investors and the public (often via their quarterly and/or annual earnings calls) to encourage further investments in their businesses. According to the 2020 Wells Fargo/Gallup Investor and Retirement Optimism Index survey, 75% of U.S. investors are not familiar with sustainable investing, while almost the same proportion say they would be somewhat to very likely to invest in stocks or funds that align with their values and beliefs. Here’s what you need to know—whether you’re familiar with the concept or not.
What is Sustainable Investing?
Sustainable investing is a principle in which investors seek to align their investments with their social and environmental values—in theory, to make the world a better place, to benefit the environment or society in general. With sustainable investing, the goal is still to generate returns over the long term, but turning a profit is not the ONLY goal. The terms socially responsible investing, ethical investing, impact investing, and values-based investing can be used interchangeably. This strategy can mean you avoid investing in companies or industries that conflict with your values, and it can mean that you invest in companies that you feel will advance environmental and social goals.
Sustainable investing has two goals:
- Generate long-term returns
- Have a positive societal impact
Sustainable investing is rooted in CSR and ESG—terms you’ve likely heard more in recent years as companies look to reduce their environmental footprint, address biases and inequities present in their workplaces, culture, and societies, and support causes that are environmentally and socially responsible. CSR stands for corporate social responsibility, which is a model that encourages business to be socially accountable to the communities and environments they do business in. ESG has a variety of meanings, but, in general, it stands for Environmental, Social, and Governance. ESG criteria and companies’ ESG practices factor heavily into investment decisions as more investors are screening and evaluating the companies in which they choose to invest. Some mutual funds, brokerage firms, and robo-advisors even offer products that include ESG criteria/scores, so investors can make more educated decisions if sustainable investing is important to their strategy.
According to the CFA Institute:
- Environmental factors are those that consider conservation of the natural word and may include climate change, natural resource conservation, carbon emissions, air and water pollution, biodiversity, deforestation, energy efficiency, clean technology, waste management, treatment of animals, and water scarcity.
- Social factors take into consideration people, relationships, and overall wellbeing and may include customer satisfaction, data protection and privacy, supplier relationships, working conditions, charitable giving, gender and diversity, employee engagement, community relations, human rights, employee benefits, workplace safety, and labor standards.
- Governance are the standards applied to running a company and may include board of directors’ composition, transparent business practices, anti-bribery and anti-corruption policies, executive compensation, lobbying, political contributions, tax transparency, and whistleblower rights.
The Origins of Sustainable Investing
The term may be new, but the concept is not. The origins are unclear, but there have been documented cases, especially in religious sects, of avoiding investing or profiting off certain businesses and activities. According to The Balance, Quakers affiliated with the Religious Society of Friends refused to participate in the slave trade in the 1700s. The Methodist movement’s founder, John Wesley, encouraged his followers to eschew profiting at their neighbors’ expense. To take it a step further, they avoided investing in or partnering with people who earned their income through the sale of alcohol, tobacco, weapons, or gambling—sometimes referred to as sin stocks as they are associated with prohibited religious doctrine and/or unethical or immoral practices. Shari’a-compliant investing encouraged avoiding investments related to activities prohibited by the Islamic religion per the Quran (or Koran).
The 1960s in the U.S. was a time of awakening and protests as a result. Many Americans did not support the U.S.’s involvement in the Vietnam War, caused great strife across the country. Calls for boycotts of companies producing weapons for use in the war were prevalent in the protests. At the same time, civil rights and racial inequities were at the forefront of the country’s political, economic, and social discussions.
The 1970s brought up more awareness of labor rights and issues and environmental practices and protection at American companies. The creation of Earth Day in 1970 and the Three Mile Island nuclear power plant accident heightened environmental activism. The 1980s brought about divestments from South African companies in the wake of apartheid policies. Fast forward to today and you can probably look at any news outlet on any day and find some form of protest, boycott, call to action, or call out related to a company’s business practices within the ESG realm.
ESG vs. Sustainable Investing
ESG investing is a form of the broader sustainable investing. While they are not exactly the same, we are using them interchangeably in this instance, as to consider ESG factors means you are approaching investing with sustainability (and social responsibility) in mind.
How Does Sustainable Investing Work?
Investors have (almost) endless investment options to choose from when building their portfolio. At its core, investors can make investment decisions by screening stocks and funds based on certain criteria that they deem important to them. If sustainable investing—aligning where you put your money with your values, beliefs, and goals—is important to you, look specifically for ESG funds. This may also mean avoiding certain industries that contradict the ESG values you have identified—also called negative or exclusionary screening.
How Can You Identify Sustainable Funds?
Many investment companies are assigning ESG scores to funds or stocks to help investors identify which investments align with their values and goals. But buyer beware: While many companies are being more transparent about their business practices and corporate structures, just because they have been assigned an ESG score or rating doesn’t mean that the fund is designed for ESG investing. There isn’t consistency in naming conventions across the financial realm, further complicating this investment practice. One step you can take yourself is to examine the fund’s prospectus, a SEC-required guide that explains a fund’s investment strategy, who runs the fund, how much it costs, and the major risks. For real peace of mind, a financial advisor can assist with identifying the appropriate stocks and funds that align with your goals. There are also stock, mutual fund, and ETF screens that can help you find investments that meet whatever criteria you choose.
Expense ratios—or the percentage of your investment that goes toward management or firm/advisor fees—are an important consideration when making investment decisions. ESG funds have similar expense ratios to traditional mutual funds, which means you may be able to sustainably invest without having to pay more to do so.
A growing number of mutual funds, ETFs, and stocks with socially responsible mandates are available to investors. Under this principle, it may take a little more research and analysis to find the right investments for you, but it can pay back in dividends by knowing you’re acting in accordance with your beliefs and values and knowing that you have the power to make an impact on society and the environment.
Every strategy is dependent on a variety of different factors, so make sure you read the fine print.
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