Do you care about social justice and the environment? Are you wondering how you can incorporate these values in the way you invest your money and your retirement savings? This is where sustainable investing comes in. It allows you to invest in a way that aligns with your beliefs and core values. It’s something more people are starting to think about. In this blog, we are going to explore sustainable investing in depth, including the 3 most popular sustainable investing strategies.
Sustainable investing/ESG investing defined
Sustainable investing involves incorporating environmental, social and corporate governance (ESG) criteria into one’s investment or retirement savings portfolio. Let’s say you don’t like private prisons and gun violence, and you like companies that give a fair wage to their employees and are serious about lowering their carbon footprint. Sustainable investing is a way to reflect these values into how you invest your money. It is also a great way to diversify your portfolio.
Is sustainable investing the same as ESG?
They are slightly different but the main concept for both is that you try to make money while supporting companies that do good. The main difference between ESG and sustainability investing is that ESG sets a specific criteria to define the environmental, social, and governance systems as sustainable. Many people use sustainable investing, ESG, Socially Responsible Investing (SRI), ethical, and green investing interchangeably. How each strategy is executed may be slightly different but the overall concept is the same.
How hard is it to add sustainable investments to my portfolio?
Historically, it was no easy task to add sustainable investments to your portfolio. The fees were high, there weren’t many ESG funds, and 401(k)s didn’t offer them. This has now changed and it’s much easier to diversify your portfolio and add sustainable investments. Now, let’s examine how well you can make money when you do ESG or SRI investing.
Socially Responsible Investing Performance: Is sustainable investing profitable?
Sustainable investing has come a long way in recent years. Let’s look at several high-profile studies from the past few years to determine if sustainable investing is profitable.
In a 2019 study conducted by the Morgan Stanley Institute for Sustainable Investing (Sustainable Reality: Analyzing Risk and Returns of Sustainable Funds), the data showed that there is no financial trade-off in the returns of sustainable funds compared to traditional funds. Morgan Stanley analyzed the return and risk performance of ESG-focused mutual and exchange-traded funds (ETFs) against traditional counterparts from 2004 to 2018.
In 2015, Oxford University and Arabesque Partners released a meta-study (From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance) which looked at more than 200 sources, including academic studies, industry reports, newspaper articles and books. Their study showed that “88 percent of reviewed sources find that companies with robust sustainability practices demonstrate better operational performance, which ultimately translates into cash flows.” Furthermore, “80 percent of the reviewed studies demonstrate that prudent sustainability practices have a positive influence on investment performance.”
In 2020, the NYU Stern Center for Sustainable Business released a comprehensive ESG report that analyzed 1,000+ meta-studies on corporate financial performance and investment performance, published between 2015-2020. Uncovering the Relationship by Aggregating 1,000 Plus Studies Published between 2015-2020. This meta-study found a positive correlation between ESG and corporate financial performance. 59 percent of ESG stock portfolios showed similar or better performance relative to conventional investment approaches while only 14 percent found negative results.
From these studies, we can see how there’s ample evidence saying that sustainable investing can at least perform as well as traditional funds, and in some cases perform even better.
How do you do sustainable investing? 3 popular sustainable investing strategies.
1. Green ETFs
One popular sustainable investing strategy is investing in “green” ETFs. Green ETFs invest in companies that support environmentally-friendly businesses. Basically you are investing in companies that are good for the environment. Green ETFs are generally categorized as broad clean energy, wind or solar. There is no single definition for the word “green” so it is up to the investor to determine if the fund’s values align with their own.
The only problem with these green ETFs is that you are investing in a field that is highly competitive and technology is rapidly changing. Many of the green investments also involve newer and smaller companies. This means that a solar or wind company that’s popular now may no longer be in operation 10 years from now.
2. Sustainability Index Funds
Another popular sustainable investing strategy is investing in sustainability index funds. These Sustainability Index Funds are index funds that will only include companies that have been screened for certain environmental, social, and corporate governance (ESG) criteria. Examples of criteria include if they are generating water pollution or causing deforestation. These will count against the company. If they have good labor standards then it’s a plus.
Sustainability index funds exclude “sin” stocks – like adult entertainment, alcohol, tobacco, weapons, fossil fuels, gambling, and nuclear power.
Sustainability Index Funds will contain more companies across various industries, which means that it’s more diversified. A clean energy ETF might contain 80 stocks compared to a sustainability index fund which might contain 1,500 stocks.
If you are interested in sustainability index funds,Fidelity has 2 “sustainability” stock index funds and 1 sustainability bond index fund. Vanguard has 2 “ESG” stock ETFs and 1 ESG mutual fund. Northern Trust also has sustainability stock funds that can be purchased in Fidelity or any other brokerage.
In your 401(k) investment lineup you can look for the word “sustainable.” If you find a fund that says “U.S. Sustainability Index,” then that’s likely invested in U.S. large companies that have good ESG ratings. In my experience, it’s not that common to have Sustainable funds in 401(k)s.
Sustainability Index Funds are index funds which means that you’re paying lower fees. Lower fees mean that you get to keep more of your money. If you like to know more about why index funds are great, check out our blog on Fidelity index funds for beginners.
3. Actively Managed Funds
Actively managed funds pick socially responsible companies that have attractive valuations and higher potential returns. These funds use a manager, or a team of managers, to pick “green” companies that they think will outperform the market. This can appeal to some people. However, one of the negatives of actively managed funds is that it’s an active fund. This means that you are probably going to pay more in fees.
How to get started with ESG investing
ESG investing doesn’t need to be complicated. Sustainable investment opportunities continue to grow as companies make more ethically conscious decisions. You need to think about what you will and won’t support and what industries you want to focus on.
While it is possible to start a sustainable investment portfolio on your own, it will take a lot of time and work. Working with a fiduciary financial advisor will mean that you will have access to more investment opportunities without the need to do all of the research yourself. They will also help you determine your risk tolerance, and your long and short term goals.
Is it good to invest in ESG funds?
ESG funds are said to be good for people who want to invest in socially responsible and sustainable businesses. However, are people really investing in good companies, or is it all just marketing? We will investigate Amazon and McDonald’s as examples.
Amazon is the 4th largest holding in a popular ESG ETF. In 2020, MSCI — the largest ESG index provider — bumped up Amazon’s ESG rating from BB to BBB. Amazon claims that its emissions from shipping are only one-seventh of Walmart’s. However, Amazon generated 465 million pounds of plastic packaging waste in 2019, and some of those end up polluting our rivers and oceans. How do you reconcile these?
Bloomberg Businessweek did a detailed analysis on every ESG rating upgrade that MSCI awarded to companies in the S&P 500 from January 2020 to June 2021. They found that the impact of a company on the environment hardly gets factored in. For example, MSCI upgraded McDonald’s ESG rating, even though it generated more greenhouse gas emissions in 2019 than Portugal. McDonald’s produces more than 53,000,000 tons of carbon dioxide per year, and its emissions have increased about 7% in past four years. Why did MSCI upgrade McDonald’s ESG Rating? Because MSCI determined that climate change does not pose a risk to the company’s bottom line. Not what you would expect.
This analysis shows that we may need to approach sustainability/ESG/SRI investing with a grain of salt. However, if you do want to try your best to invest sustainably then you can also do further research into what companies you would personally like to invest in to make sure that they align with your values.
Should I do sustainable investing for my own investments?
Sustainable investments are definitely becoming more mainstream and it is predicted that it will become the norm in the future. Each year it is becoming easier for investors to “greenify” their portfolio. According to the Global Sustainable Investment Alliance (GSIA), sustainable investing is on the rise. Assets under management have surged from $30.7 trillion in 2018 to $35.3 trillion in 2020.
I like the idea of being able to invest responsibly. However, after investigating sustainable investments further, the question before us is, can we actually do it effectively? Or is it a mirage? I volunteer as Board Treasurer for a non-profit, and we’re having the same discussion ourselves. It’s a tough decision.
Want to create a sustainable investment portfolio?
ESG investing can help put your capital to work and positively contribute to a better world and a more sustainable future. We would love to know if you are currently doing sustainable investing or if it’s something you are thinking about. If you want help with your finances and are interested in having a comprehensive financial plan, feel free to schedule a discovery call with one of our financial advisors today!
Alvin Carlos, CFP®, CFA is an investment advisor and fee-only financial planner, in Washington, D.C that works with clients across the country. He has a Master’s degree in International Relations from SAIS-Johns Hopkins. Alvin is a partner of District Capital, a financial planning firm designed to help professionals in their 30s and 40s achieve their financial goals through smart investing, reducing taxes, retirement planning, and maximizing their money. Schedule a free discovery call to learn how we can help elevate your finances.