With all of the talk these days about climate change and what can be done, as a society, to lower our greenhouse gas emissions, I want to dive deeper with you into sustainable investing and what it might look like for you to invest sustainably. If you’re at all concerned with the evidence in favor of climate change that you’ve been seeing in the news lately and you are investing for retirement (which, if you’re a LifeSighted blog reader, you know you should be doing!), it’s worth understanding what sustainable investing is, why you should be investing sustainably, and how to go about investing sustainably.
What is Sustainable Investing?
Investment managers have many definitions for the various types of responsible investing, not to mention all the different acronyms: ESG, SRI, impact investing, sustainable investing, etc. It makes it difficult for the average investor to understand what a manager is actually doing with your money. Maybe they’re investing in causes you actually care about, but then again, maybe they’re not. If you’re interested in any of these types of investments, it behooves you to learn what these phrases typically mean so you can best match the fund’s investment style with your personal responsible investing philosophy.
ESG is a common acronym you’ll see. It typically refers to the environmental, social, and governance practices of a company. Most ESG fund managers perform a financial analysis on a company first and then look at the ESG factors to enhance the analysis. This allows them to choose investments that have the best ESG scores (or eliminate the worst) from a bucket of companies they’ve already identified with good financials.
While the ESG considerations might be the most important criteria to you when selecting investments (and likely very important to the fund manager as well), it’s worth remembering that the performance of the underlying investments is generally the most important criteria to the ESG investment manager.
Variations of SRI I’ve seen include:
- Socially responsible investing and
- Sustainable, Responsible, and Impact investing
At first glance, these might appear to have different meanings, but in actuality, they have been used interchangeably as of late. SRI is rooted in choosing (or excluding) companies based on ethical grounds, which could stem from religious beliefs, personal values, or political sentiments.
Unlike ESG, SRI fund managers try to balance the importance of filtering out investment choices by the SRI criteria with the importance of investment performance.
Keep in mind that it can be difficult to find responsible investment funds that perfectly match your beliefs and values. If you want to use your money to invest in only companies that are aligned with you, you’ll need to do the research and pick individual companies yourself, either publicly traded or private (if you have enough to invest). Assuming you’re not so inclined, though, you may need to be OK with simply finding the closest match.
Impact investing takes it one step further than SRI. Responsible investing criteria comes first when looking to make an impact, while investment performance is of secondary importance.
Due to its nature, impact investing is often in private companies or non-profits focused on progress in the areas the investor cares about.
How We’ll Define Sustainable Investing
Sustainable investing is, ultimately, a subset of ESG. We choose to primarily focus on the E, investing in companies that are environmentally conscientious; companies with a desire to reduce their greenhouse gas emissions and an eye toward the future of energy. As a consequence, those companies tend to have solid governance practices and will push society toward finding/using sustainable energy solutions (thus also ticking the S & G boxes).
As our investment philosophy is structured around maintaining focus on things that can be measured objectively and controlled, it also helps that more and more metrics (like Morningstar’s Sustainalytics) are being developed to quantify a company’s environmental impact.
Side note: While there’s absolutely nothing wrong with investing in other social causes you believe in (and there are plenty that we believe in ourselves), people’s beliefs and values can be so personal that it’s difficult to discuss them objectively in a mass media format, such as blogging. Feel free to reach out directly if you’d like to discuss how to invest according to your values.
Why Should I Invest in Sustainability?
Companies are not explicitly incentivized to help solve the environmental challenges the planet is facing, nor are they directly punished for failing to do so (i.e., via political policy like a carbon tax). Without a financial incentive, it’s unlikely that corporate leadership will adopt sustainable practices, which can be more expensive than current, non-sustainable solutions.
By shifting investments toward companies that do prioritize sustainability and away from those who don’t, we can, as a society, begin to give companies a greater incentive to do better, largely removing politics from the equation. It gives the investor a chance to be a part of the solution by voting with their money, and as the old adage goes, “money talks.”
As more and more money is managed sustainably, we’re providing the sustainable companies with access to a bigger overall pool of investment capital than non-sustainable companies would get access to. The CEOs of those non-sustainable companies will hopefully take notice of where the money is going and adapt toward more sustainable practices.
Performance of Sustainable Investments
Now, you might be thinking, “this all sounds awesome, but I’m not willing to sacrifice investment returns.” Good news: you don’t have to.
The chart below shows the growth of $1 from 2008 to 2020 if it were invested in the DFA US All Cap Core Sustainability index compared to their non-sustainable DFA US All Cap Core index. Over the same time period, the sustainability index grew from $1 to $3.29. The non-sustainable index only grew to $3.01.
This isn’t to say sustainable investments will outperform in the long run (though there’s research suggesting that’s not an unreasonable conclusion) or all the time, but rather that the investment returns are at least comparable. You don’t necessarily have to give up performance to invest in sustainable companies.
Societal Impact and Returns
At the end of the day, by putting our money where our mouth is, our end goal is to impact the world and make it a better place, both now and in the future. So, what sort of impact might investing sustainably have?
According to environmental scientists, climate change is the most important environmental issue that needs to be tackled today. They also tell us there isn’t much time to reverse the damage that’s already been done. Unfortunately, not all companies know what they need to do in order to reduce their emissions.
By investing in sustainability, we’re able to:
- continue to increase the metrics that can be used to measure a company’s greenhouse gas emissions, which in turn can be used to educate the corporate leaders on what needs to be done to better their scores, and
- provide more backing to companies that promote solutions which reduce overall greenhouse gas emissions, either directly or indirectly.
Sustainable investments tend to promote the use of renewable energy sources, like solar, hydrogen, or even electricity, when providing their products or services. By investing in those companies, you’re helping to push the world in that direction.
Interesting side note: though you may not think of electricity as a clean energy source, it can be. There’s an argument that our path to net-zero energy lies in normalizing the use of electricity to power things that would traditionally rely on fossil fuels, or less renewable energy sources, like cars. By using electricity, we’re able to concentrate the sustainability efforts to a smaller number of energy sources (power plants) that supply the electricity to the people. It’s far easier to clean the energy in a fewer number of places and pass the clean energy out to people to use in their cars, for example, than it is to clean the energy in the millions of gas-powered cars on the roads.
How to Invest Sustainably
In general, you’ll want to stick with your overall investment strategy (i.e., how much stocks vs. bonds you want in your portfolio, how much US investments vs. international investments vs. emerging markets, how much large cap vs. small cap, etc.).
The easiest and most diverse way to get started is by investing in mutual funds or ETFs. If you’re going this route, you’ll then want to find the sustainable funds (from an investment manager that you trust, like DFA or Vanguard) that fit for each allocation within your overall strategy (i.e., US Large Cap Sustainability, Emerging Markets Sustainability, etc.).
When selecting fund managers, you’ll want to understand whether they’re applying positive screens (only including the most sustainable companies) or negative screens (excluding the least sustainable companies) when choosing the company they include in the fund or ETF. In the funds we use, a little bit of both is happening, but it’s primarily the least sustainable companies (like airlines and oil/gas companies) that are being excluded from the funds.
As in all types of investing, there’s no one-size-fits-all approach. We’ve chosen to provide sustainable investments as the go-to option to our clients because we believe the investment performance will be similar (if not better) than non-sustainable options. This is also one way we, as investment advisors, can help make an impact to help combat climate change. Ultimately, sustainable investing needs to be a reflection of your personal philosophy in how to best improve the world.