Sustainable investing, specifically, means investing in companies that follow sustainable practices in their business activities. Sometimes, the kind of accounting framework used is referred to as the “triple bottom line,” meaning a company’s financial decisions include a focus on people, profits, and the planet. This article will address the broader meaning of sustainability; related terms such as environmental, social, and governance (ESG) investing; and ways you can invest in sustainability.
What Is Sustainability?
Sustainability can be defined as the integration of environmental health, social equity, and economic vitality to create thriving, healthy, diverse, and resilient communities for present and future generations.
Alternate names: Values-based, impactAcronyms: ESG, SRI (socially responsible investing)
How Sustainable Investing Works
Sustainable investing began with choosing which companies to invest in—or not invest in— through the use of screening criteria based on the company’s industry or its sustainability practices. Some early examples of such criteria included avoidance of tobacco companies, weapons makers, or companies that committed human rights violations like apartheid. Today, ESG investors employ many more criteria that they may also use as positive screens for company practices that investors hope to reward or enhance, such as:
Carbon emissions mitigation Green building strategies that address environmental impacts on climate and people Community development Board diversity and gender equality
Investors choosing a more active approach may also file shareholder resolutions with the firms whose shares they own, encouraging the share issuers to follow sustainable practices or discouraging unsustainable ones. Institutional investors, such as pension funds and money management funds, are also starting to put more of their assets into sustainable investing. The Forum for Sustainable and Responsible Investment Foundation identified 836 registered investment companies with ESG assets in 2020. Those assets included 718 mutual funds and 94 exchange-traded funds (ETFs). ESG assets managed by registered investment companies rose 19% to total $3.10 trillion in 2020, up from $2.61 trillion in 2018.
Why Sustainability Is an Important Factor for Investors
If sustainability in general is important to you, then sustainable investing means you can align your investments with your values by buying securities of companies that follow business practices informed by ESG principles. That doesn’t mean you have to give up investment performance, though. Several studies have shown that sustainable mutual funds generally perform in line with comparable funds not composed of stocks that are highly rated for sustainability factors. The Morgan Stanley Institute for Sustainable Investing found, for example, that from 2004 to 2018, sustainable funds performed essentially the same as comparable traditional funds, but with 20% less downside deviation.
Types of Sustainability
Sustainability is a broad term, but it can be assessed at companies by using ESG criteria. These factors are often measured using a variety of information sources. As an example, independent investment research firm Morningstar Inc. determines a company’s ESG rating by analyzing the company’s risks with its own system of measuring a company’s exposure to material ESG risks, then gauging how likely those risks are to occur. ESG rating firms may use their own indicators, or evaluate information from outside sources such as governmental regulatory agencies, news reports, and data contained in the company’s financial disclosures.
Environmental
Environmental sustainability relates to the company’s practices regarding its use of or interaction with natural resources, clean technology, or impact on climate change.
Social
Social elements of sustainability can involve workplace safety practices, labor relations, diversity, community development, or human rights, among other topics.
Governance
The governance aspect of sustainability may include consideration of the company’s board independence and diversity, its anti-corruption policies, and political contributions made by the firm, along with other benchmarks. To build a mutual fund that invests with a sustainability lens, these criteria are applied as either a positive or negative screen. A positive, or affirmative, screen works by actively seeking companies to include based on the desired criteria. A negative, or exclusionary, screen removes investments in companies that use undesired practices or that are involved in business activities that do not align with a fund’s values. Investing sustainably may mean using one or a combination of any of these and other criteria.
Sustainable Investing Options
If you don’t want to screen for suitable individual sustainable stocks to invest in yourself, there are mutual funds and ETFs that invest based on sustainability data as well. By investing in a mutual fund or ETF that uses sustainability criteria to accomplish its investment objective, you commit money to sustainability without having to analyze and track each stock yourself, saving yourself considerable time. One example of a sustainable ETF is the iShares Global Clean Energy ETF. This fund invests in securities that comprise the S&P Global Clean Energy Index, which is made up of companies that are involved in clean energy production, or clean energy equipment and technology. Another example of a sustainable ETF is the iShares ESG Aware US Aggregate Bond ETF, which tracks an index of bond issuers evaluated based on ESG factors. You also can investigate whether your employer’s 401(k) or your IRAs have ESG investment options, and reallocate some or all of your retirement savings there.
Pros and Cons of Sustainable Investing
Pros Explained
Aligns your investments with your values: Sustainable investing allows you to invest in a way that aligns with your own values on the environment, social impact, and company governance. It may also help you avoid investing in companies whose business practices don’t line up with your principles. Increases portfolio diversification: The ESG approach can provide diversification to your portfolio by including assets selected using different factors than are employed in traditional portfolio construction.
Cons Explained
Takes time and money to evaluate: Screening potential investments based on sustainability criteria takes additional time, and can be costly for individual investors. While the volume of ESG data disclosed by and compiled on companies has increased significantly in the last few years, it’s often only available by subscription. However, you can offload much of that research to a fund manager by investing in a mutual fund or ETF. Companies may be deceptive about how sustainable their practices really are: Because of the popularity of sustainability with consumers, companies may spend considerable time and effort promoting themselves as good practitioners of it, conduct known as “greenwashing,” even if that isn’t really the case.
