Sustainable investing seeks to align investment decisions with the investor’s social and environmental values, while still generating long-term returns. Usually, making a profit is a top priority for investors, but with sustainable investing, profit is not the only goal. Making an impact is just as important, if not more.
Learn what sustainable investing is and how it works, plus some easy strategies if you want to invest in a way that doesn’t go against your conscience.
Definition and Examples of Sustainable Investment
Sustainable investing is a strategy in which you invest in a way that benefits the environment or society. It can be as simple as avoiding companies or industries whose products conflict with your goals, morals, and values. You can also invest in methods that you think will achieve certain goals. You may hear sustainable investing referred to as ethical investing, impact investing, socially responsible investing, and values-based investing.
Alternative names: Ethical investing, impact investing, socially responsible investing, values-based investing
By the end of 2019, assets professionally managed using sustainable strategies had grown to $17.1 trillion, up 42% over the previous two years, according to the US SIF Foundation. The organization also estimated that $1 out of every $3 under professional management is invested in sustainable practices.
But the history of socially responsible investing, or SRI, in the United States, dates back hundreds of years. Quakers affiliated with the Religious Society of Friends are sometimes credited as early practitioners because they refused to participate in the slave trade in the 18th century. More recently, socially responsible investors supported projects that advanced civil rights in the 1960s and were pulled from businesses in South Africa in protest of the apartheid policies of the 1980s.
In the past, some investors avoided sustainable investing, fearing that it would reduce returns. But a growing body of research suggests otherwise.
In 2020, sustainable funds outperformed, on average, both their conventional peers and their indexes, according to Morningstar’s 2021 Sustainable Funds US Report. For the subsequent three-year period, 75% of sustainable funds are rated in the top half of the Morningstar category. 52% of sustainable equity funds are rated in the top quartile.
How does sustainable investing work?
Although they are sometimes used interchangeably, there are two main types of sustainable investing – Socially Responsible Investment (SRI) which takes an exclusionary approach, and a broader path to Environmental, Social and Governance (ESG) investment.
With SRI, investors can make investment decisions by first screening funds or stocks based on certain criteria.
Many investors simply refuse to invest in companies that go against their values. They may avoid investing in ” sin stocks,” or those issued by companies in the tobacco, alcohol, and gambling industries, or companies that make weapons.
Some mutual funds and exchange-traded funds (ETFs) appeal to sustainable investors by avoiding certain industries. For example, as of December. On 31, 2020, the SPDR S&P 500 Fossil Fuel Reserves Free ETF (SPYX) was invested in 491 of the 500 companies in the S&P 500, excluding those with fossil fuel reserves.
On the other hand, investing in ESG often takes a broader and more proactive approach by evaluating corporate due diligence factors. For example, an oil and gas company can be considered a responsible investment if it is committed to reducing emissions and giving back to its communities.
ESG investment decisions tend to rely on measurable ESG factors, as provided by analysts. for example:
Environmental: carbon emissions, water use, and conservation, clean technology
Social: Workplace safety and benefits issues, community development, diversity, and anti-bias
Governance: Board diversity, corporate political contributions, anti-corruption policies
These factors can be used to value individual stocks, but many mutual funds and ETFs focus exclusively on highly rated companies. One example is Vanguard’s Global ESG Select Stock Fund Investor Shares (VEIGX). According to Vanguard, this fund is intended for investors seeking to “deal with companies with leading ESG practices” but may not be ideal for those looking to exclude certain sectors or companies from investments.
As of December. On 31, 2020, VEIGX had 38 holdings, the largest of which is Microsoft. Microsoft has publicly stated the extension of CSR goals and commitments to sustainability.
Then there are funds that focus on specific social and environmental goals. For example, VanEck Vectors Green Bond ETF (GRNB) invests in green bonds, which are bonds whose proceeds go toward environmentally friendly projects. You can also find funds that invest in advancing issues such as gender equality, such as the SPDR SSGA Gender Diversity Index ETF (SHE), or clean water, such as the Fidelity Water Sustainability Fund (FLOW).
What does sustainable investing mean for individual investors?
Investors have a number of different investment options to choose from that can align with their values and philosophies. As sustainable investing gains more momentum, companies are disclosing more information to investors so they can evaluate investment opportunities with that in mind. For example, public companies now often use earnings call files to effectively communicate their ESG strategies.
Keep in mind that when a company announces its commitment to human rights or clean energy, this does not necessarily mean that it will continue to operate.
An investment firm’s ESG criteria can be one of the tools investors use to determine how companies are measured. Investment firms often assign ESG ratings to mutual funds and ETFs, but the presence of a score does not mean that the fund is designed to invest in an ESG.
If you want to invest in sustainable funds, look specifically for ESG funds or those that target your goal. Using a stock, mutual fund, or ETF screening tool can also help you research investments that meet any ethical criteria you choose.
Research has also found that an ESG fund’s expense ratios – the percentage of fee-oriented investment – are usually similar to what you’d pay for a traditional mutual fund in the same category. This means that investors may be able to get started on sustainable investing without paying more to do so.
Sustainable investing is a strategy for investors who seek to earn financial returns in a manner consistent with their values.
By the end of 2019, about $1 out of every $3 was invested under professional management in the United States in accordance with sustainable practices.
Some investors avoid investments in stocks or industries that do not align with their goals.
ESG ratings can help investors choose individual stocks and funds to invest in line with their goals and values.