Understanding Sustainable Investing

Interest in sustainable investing is growing. Investors know they can drive change through their portfolios, and companies are building good products to help. Understanding sustainable investing by looking at what it offers and why it’s pursued, plus how it’s implemented and whether it works is key for anyone looking to take their portfolio in this direction.

What is Sustainable Investing

Sustainable investing encompasses a broad list of values. The market has organized those values into three groups: Environmental – Social – Governance. Below is a sample of each.

ENVIRONMENTAL

Energy Efficiency

Biodiversity/Land Use

Climate Change

Water Scarcity

SOCIAL

Labor Standards

Working Conditions

Human Rights

Diversity

GOVERNANCE

Shareholder Rights

Transparency

Board Structure

Data Security

While these examples just skim sustainable investing’s surface, they highlight some common issues and concerns. Business create both positive and negative consequences. Some investors want to limit negative consequences (pollution) while others wish to support positive ones (pay equality).

It’s Pursuit

Understanding sustainable investing is easier if we have a sense of why it’s pursued and its evolution. More today than ever, investors are passionate about things like climate change, the environment, religious beliefs, corporate concerns and workplace diversity. And they want to align their long-term portfolios with their values.

Investors have always had values and concerns. But as this BlackRock piece explains, “sustainable investing used to cater to niche investors and was often considered expensive, values-focused and indifferent to performance” in that it functioned mostly by excluding stocks from portfolios. Today, the interest in sustainable investing is being matched by cheaper products that don’t limit investment options as much and focus on a bigger list of values and concerns.

I also think investors are intrigued by the potential for the market to fix things that our broken political system cannot, or will not, address. I know I am, which I recently shared in Sustainable Investing Thoughts. Partisanship is on the rise. Compromise is considered a dirty word. And no one has the incentive to address long-term problems. So, why not take one of investing’s strengths, that when done best it’s a long-term exercise, and hope it can help fix long-term problems?

Implementation

Four main ways exist to implement sustainability:

EXCLUSION: The exclusion of sectors or individual securities that are counter to an investors’ defined values. Faith-based organizations were among the first to adopt this approach.

INTEGRATION: A combination of exclusion and inclusion helping to remove the “bad actors” and emphasizing the “good actors”. For example, if an investor wants a clean energy portfolio, instead of screening out all energy companies they can remove the companies focused on fossil fuels and invest in renewable energy companies.

IMPACT INVESTING: Targeted investment in companies or funds, often private, intended to generate social or environmental impact alongside financial return.

PROXY VOTING: Exercise your right as an owner by voting your proxies in accordance with your proxy voting guidelines.

Does it Work?

Understanding sustainable investing is helpful. And its evolution is important. But we still need to understand if investing this way hurts your returns. For some, that’s not important, but others don’t want to sacrifice performance. I touched on this recently in Does Sustainable Investing Hurt Returns, where I shared data from a study with this conclusion:

Our results suggest that investors can pursue environmental goals without compromising sound investment principles.“Greenhouse Gas Emissions and Expected Returns by Wei Day, Phillip Meyer-Brauns

More studies support this research and take it even further, sharing that sustainable investing has not only held its own, but outperformed. And as the products and strategies improve, and capital flows into them, it’s reasonable to assume that the performance gap that was a criticism of sustainable investing before will not exist over the long-term.