What is sustainable investing? Why so many different names? It can mean different things to different people, and comes by many names, and in this episode we will take a quick look at different ways to approach it.
- Impact Questionnaire (https://www.ethosesg.com/forty4-financial/take-an-impact-assessment)
Today, let's talk about what sustainable investing is. It can mean different things to different people, and comes by many names, and in this episode we will take a quick look at different ways to approach it.
So first, why so many different names? When it comes to sustainable investing, there's ESG, socially responsible, sustainable, impact, responsible, values based and others, and believe it or not, they all have merit or historical background. And it kind of depends what you're trying to accomplish with it.
For me, I decided to go with the term sustainable investing, partly because I like the sound of it, but most importantly because it fits my approach – to invest in a manner that is sustainable both from a financial perspective, as well as from the impact or exposure of the associated portfolio.
Historically, sustainable investing was limited sin stocks, like tobacco, alcohol, gambling, weapons, and the like. It was first set in motion by the Rockefeller family back in the 1970’s as a way to reflect the values of the family.
In recent years, it has evolved to be much more nuanced, especially as data is becoming more widely available. The foundation can be the exclusionary approach, where you have certain things you want to avoid, similar to what the Rockefellers did, avoiding the stuff you don't want to be associated with. The goal is to find companies that act or behave in a manner that is aligned with your values, or at least do not work against them.
You can then add a layer that is inclusionary on top, and focus on investments that represent what you really want to promote in your portfolio, or certain characteristics you're feeling strongly about. It can be thematic in nature, maybe focused on renewable energy, gender equality or climate change, or it can be more general in it’s approach. Again, it can be a very personal decision.
Investments can have both financial and a non-financial returns. Traditional investing focuses solely on the financial aspect, while Impact investing is more about the non-financial characteristics, such as providing low-income housing, or supporting a local economy, but having less focus on making money. Sustainable investing, in my opinion, aims to bridge the two, where there is a balance between the two returns. It can be structured to potentially yield a financial return similar to that of the broader market, while still having a profile you feel is right for you. Of course, any time you invest in a different way than the regular market, you should expect that your return can be different.
When you look at the available investment options, you are starting to see many investments that have the letters ESG in their name, and this has become a common sight in the investment world. The E, for Environment, is usually the one that is the easiest to grasp, as it is related to carbon emissions, energy efficiency, resource use, and similar. The S, for Social, covers things like gender and diversity policies, both in the workforce and the boardroom, human rights, labor standards and customer satisfaction. Finally, the G is for Governance, and looks at board independence, fair executive compensation, bribery and corruption policies and data security.
Truth be told, I don’t believe there is a so-called perfect company out there – most have room for improvement in one area or another – but some are working more diligently on addressing their issues than others.
Wall Street has done a great job adopting the ESG framework, although in a way that I find leaves room to do better. Their focus is on finding the companies that make the most money while scoring well in the various categories they have determined are appropriate for a given company. Not necessarily one that makes a positive impact in the category. It could, at least theoretically, be that a company makes a lot of money on technology to help those affected by climate change, while operating in a manner that makes the issue worse.
I think there are plenty of options to choose from, where you take the ESG framework as a great starting point, and then overlay a criteria to focus on those companies that are looking to alleviate or reduce the issues, while potentially making money in the process. With thousands of investment options out there, I do believe it is possible to build a diversified portfolio in this fashion.
One of the things that often come up when you talk sustainable investing is well, I need to and want to make money, can I do that and do it sustainably? Yes. This, as with anything investment related, there's a risk involved, even potential loss of your principle. But I do think adding the screens and investing in solid companies you feel good about, you still have the potential to make money. You may or may not have the same outcome as you would if you were invested in the traditional, broader market. But I do think that over time, performance should not be a hindrance to add a sustainable angle to your portfolio.
The longest running index around sustainability has been around since 1994. An index is a hypothetical portfolio representing a segment of the financial market, and while you can't invest directly in an index, it's a good measure to use to track the performance of a group of assets against in a standardized way. Since 1994, that socially responsible index has performed pretty much in line with the broader market. Some years better, some years worse. As you would expect when you own something different than the broader market, performance will deviate, for better or for worse.
But over time, there is a convergence of the returns, which from my point of view, is really quite comforting. You do not necessarily need to give up a financial return in order to feel good about the companies you're investing in.
Now, another myth is that it's expensive to invest in sustainable options. That used to be the case, so it's a myth with a historical relevance. It's not so much the case anymore. The financial industry has evolved tremendously over the past 5-10 years, where cost is much less of a component in portfolio construction process than it used to be. And now you can find many options that have a sustainable component that are comparable to the broader options from a cost perspective. So that should not be a major hindrance any more. Of course, you do have to pay attention to it because there are some that are very expensive, just as there are if you are looking at more generic options. In general, when constructing a portfolio, costs should be a consideration. It's not necessarily the primary but it should definitely be considered as you're as you're looking at your portfolio.
When you are going through this exercise of investing in a manner that is aligned with your values, keep in mind that perfect may not be attainable. But getting started is better than not doing anything. And even looking for a partial improvement can make a difference, especially if you keep making these little changes over time. So don't let the goal of perfect keep you from getting started.
In the show notes, I have a link to a short quiz to find your impact persona, to give you an idea as to what values are more important for you to focus from a sustainability point of view, and different screening options. I think that is a great place to start. If you would like some additional insights, feel free to reach out for a conversation, it is a topic I love, and I can walk you through what options you may have available. You can also go to my website, http://www.forty4financial.com, for more information.