Investing for Good – Sustainable Investing
ESG investing, SRI, impact investing, thematic investing, stock screeners; there are many ways to invest your dollars so they’re working for the greater good. Although there are many different names for these methods, they all share the common objective of investing your money in companies that align with your values and are trying to make a positive change. This primer into the wide world of sustainable investing will give you a little back story on how the movement was started, the key differences between the different methodologies and what you need to know to get started.
What many people don’t know, is that the sustainable investing movement started with religious groups. They began seeking out investments that more closely aligned with their ethical beliefs and religious practices. This included screening out or removing from their investment portfolios companies in the alcohol, weapons, tobacco or gambling industries.
The first sustainable investment fund was created in the 1970s Vietnam War era when social and environmental movements were gaining momentum. In response, people wanted to make sure that their dollars were not going to causes they didn’t support. As the concept gained in popularity, sustainable investing morphed into what is known today as ESG investing
What is ESG Investing?
Investing that considers environmental, social and governance factors can fall under the umbrella of ESG investing. Different types of sustainable investing incorporate some, if not all, of the three ESG factors with varying degrees of focus.
ESG provides an ethical standard that can be used to measure a company’s operations. This includes examining specific policies and procedures under the ESG lens while also considering the impact on overall performance as well as the bottom line. ESG investment funds look for companies with responsible environmental, social and governance practices that will support the growth and long-term viability of the company. However, there isn’t a widely accepted standard of what ESG means in the marketplace. This, coupled with the fact that good performance is still the main goal, means people committed to ESG may still wind up investing in companies and industries they don’t approve of. Now that we understand ESG investing as a whole, we can break it down into its parts and look at the different issues they address.
E – Environmental Factors
The environmental component factors in any actions a company takes that either positively or adversely affect the local, national, or global habitats. Environmental factors that companies may address include:
- Emission standards
- Renewable energy
- Policies and procedures related to climate change
- Environmental initiatives (i.e. planting trees)
- Waste disposal practices
- Relationship with regulatory agencies like the Environmental Protection Agency (EPA)
- Sustainable resource practices and sourcing
S – Social Factors
The social component addresses anything a company does that affects people. This includes their employees, stakeholders of the company and the general public. Companies that have programs that give back to society and local communities, as well as support employee wellbeing usually rank high in social factors. Some examples of social factors include:
- Company mission
- Employee benefits
- Employee development and turnover
- Consumer litigation history
- Public stances (or lack thereof) on social issues
- Diversity and inclusion practices
G – Governance Factors
A company’s governance policies address leadership and decision-making issues. The corporate governance factor relates to the board of directors, steering committees, and shareholder relations. When considering governance criteria, investors can look at how the business is run, how the management within the company responds to shareholder concerns and how business practices align with the stated mission and vision of the organization. Specific governance factors to consider include:
- Executive compensation and perks
- Board and management diversity
- Potential severance packages
- Transparency of decision making and other relevant information
- Incentives tied to long-term progress of business values vs share price
- Conflicts of interest in the board of directors
- History with regulatory agencies
ESG vs SRI: What’s the Difference?
There can be a lot of confusion about how ESG and SRI (Socially Responsible Investing) differ. While the two are often used interchangeably, there are a few key differences.
Generally, ESG is the more commonly used term, especially when looking for sustainable mutual, exchange-traded and index funds. The reason for this is that ESG can be based on a set of standard criteria, while SRI is usually more personal to the investor. The goal of SRI is to ensure that investments and capital are aligned with the investor’s values and beliefs.
In standard ESG investing, values are taken into consideration, but the overall goal is still financial return and performance. A company may be kept in an investment portfolio as long as it has a “passing” ESG score, even if the primary business is something that you don’t believe in socially or ethically.
In an investment portfolio that is specifically made for SRI, companies would be included or excluded based on a set of values or themes, such as renewable energy, religious preferences, or human rights initiatives. While financial importance is still a priority for SRI portfolios, they have a stricter set of guidelines for what companies will or won’t be invested in.
Impact investing is another, less common form of ESG investing where social benefit is the main purpose. Investments are made into a business whose primary purpose is to provide some type of social or environmental good to their local community, the environment, or other social cause.
Impact investors are often willing to accept financial returns that are less than the industry standard to ensure that their investment dollars are being used to support a good cause. Impact investments may also be structured differently than standard investments because they are seeking to support businesses that are deemed “too risky” by larger financial institutions. One example would be micro debt and equity agreements in developing nations to support small businesses or access to resources such as clean water.
Impact investing opportunities are often available on a grassroots level with private companies. Investment in private companies may require a person to be an accredited investor, or in other words, meet an income or net worth threshold. In some communities, local organizations create impact investing funds, which can give non-accredited investors access to impact investing opportunities.
Impact investing is putting your dollars into a business that has a mission to make the world a better place. Financial returns are not the primary purpose, rather they are an added benefit to support companies that are making impacts in their respective causes.
Knowing which ESG investment option is the best in both performance and sustainability is not always easy. However, there are ways to compare different investment options to choose the right choice for your set of financial goals and social values.
Independent research companies like Morningstar and MSCI have tools that help you measure how sustainable a company is. They look at many different ESG factors and compile them in an easy to understand score.
Companies like Barron’s publish annual lists of top-performing sustainable funds that rank ESG investment choices based on both sustainability and financial returns.
Most investment companies and advisors can also help you find different ESG options and give you recommendations on which may be suited to your particular goals and values.
How do ESG Investments Perform?
One of the main arguments against sustainable and ESG investments are financial returns. Some opinions say that ESG investments have worse returns than other more conventional investment options. While returns vary between investment choices, managers and funds, it’s safe to say that ESG investments can give you similar financial returns compared to the rest of the market.
In the market volatility caused by the Coronavirus, S&P Global reported that major ESG funds outperformed the S&P 500 Index, a major indicator for the stock market and investment performance. There are many reasons why an ESG fund may perform better or worse than other conventional investments. A higher ESG rating in companies may be an indicator of quality management and resilience in volatile markets. Companies with a higher ESG rating may put more thought into their supply chains and core business processes.
ESG investments may underperform other investments for a few reasons. ESG investments may have higher fees due to the increased analysis and screenings of companies to fit the ESG criteria. Performance may also suffer if the fund is not diversified due to the inverse selection of companies that are not within the value screen. Companies that don’t follow ESG criteria may also have a higher risk of litigation, which in turn would necessitate a higher financial return to investors. Overall, ESG investments may perform better or worse than other investments, but it is up to the individual investor to prioritize financial return vs social impact and know their risk tolerances.
How to Start ESG Investing
Luckily getting started in ESG investing is easier now more than ever. Whether you’re investing through a financial advisor, self-service brokerage account, mobile app, or Robo-advisor you’ll almost always have some form of access to a sustainable ESG investment. Some employer 401(k) plans also offer sustainable investment choices (ask your plan administrator for more information).
If you’re using a mobile app or self-service brokerage platform to invest, then the first step would be research which companies or funds you might be interested in. Online platforms will often have search features than enable you to filter your results to find companies that have higher ESG ratings.
If you’re looking to invest based on a certain set of values or themes (e.g. green energy or religious views), then you might have to use more specialized services. A financial advisor or investment company that specializes in sustainable investments may be able to customize investment choices to fit your theme.
Other ways to “Invest” in ESG
If you’re not quite ready to jump into the world of investing, there are other ways that you can address ESG issues such as:
- Talk with policymakers (unions, city council, advisory boards)
- Support local non-profits through volunteering and donations
- Participate in public gardens, community cleanups, and trail restorations
- Lobby for causes that you support
Becoming active in ESG issues can give you a better insight into why it may be important for you to put your money into sustainable investments. ESG investing is about leveraging your dollars to work both for you, and what you believe in. Just as compound interest makes you money while you sleep, ESG investing is a relatively low effort way to help make the world a better place.