What is sustainable investing?
Known by many names, sustainable investing encompasses investment strategies that integrate environmental, social and governance (ESG) factors into investment analysis. The motivations behind this methodology range from investors who seek to achieve benefits beyond financial returns, such as encouraging social or environmental best practices, to those who aim to improve return potential through consideration of this extra-financial information. Initially implemented through socially responsible investing (SRI) using negative screens, investors could avoid objectionable companies or industries that conflicted with their religion, ethics or values.
In the early 20th century things like tobacco, alcohol, and gaming were among the first “sin industries” shunned by U.S. investors. Since then things have expanded to focus on the integration of ESG factors as investment criteria, though SRI strategies are still available. Taking it one step further, impact investing takes the more direct approach and aims to make intentional and measurable impacts through its investments. Sustainable investing does not imply that other forms of investing are unsustainable. Rather, its approaches aim to equip investors with additional tools for choosing investments to best meet their goals.
How is this different from traditional investing?
While the pursuit of a more conscious investing approach is a growing trend, sustainable investing offers much variety, particularly in how strategies are implemented. In considering sustainable investing, it is important to realize how a strategy implements its ESG mandate. The great diversity in sustainable investing approaches and philosophy used by investment professionals begs close examination before investing to ensure objectives are aligned.
Sustainable investments generally take the form of one or more of the following approaches.
This method typically runs an exclusionary or negative screen on the investment universe. This allows them to avoid investing in any profits from an industry or company viewed unfavorable by its investors.
The flip side of exclusion is integration. Inclusionary or positive screens are used to identify best-in-class companies, based on ESG criteria. Alternatively, ESG factors may be considered as a part of fundamental analysis for a fully integrative approach.
As stated before, impact investing goes a step further and aims to make a measurable impact on solving social or environmental issues.
What are my options?
There are various objectives that investors aim to achieve through sustainable investing. Some sustainable investors want to take into consideration all ESG criteria for a fully comprehensive approach, while others have certain issues that interest them and prefer a more specific approach. Green investing, social investing and community investing highlight some core issues that an investor may try to tackle in a more issue-specific, targeted strategy. Some religions place restrictions on how followers should invest, leading these investors to seek to avoid investing in industries that are perceived as contributing negatively to society or that do not fit within their spiritual guidelines. Others may invest responsibly because it allows them to use their money to guide businesses to benefit society.
Is there a trade-off?
There are many reasons investors incorporate ESG factors into their investing, though opinions vary on whether sustainable investing can provide superior returns. However, research has shown a correlation between investing using ESG criteria as a part of the investment process and achieving superior returns. Deutsche Bank Group Climate Change Advisors conducted a study in 2012 that found incorporating ESG data in investment analysis is “correlated with superior risk-adjusted returns at a securities level.” Another study, published in the Journal of Financial Economics, found that positive employee satisfaction scores, a social factor, are positively correlated with shareholder returns and that broad SRI screens may improve returns. (3) Some investment managers are using ESG criteria to manage investment risks and aid in downside protection. It is evident that implementation can be a determining factor in linking sustainable investing to outperformance. The Financial Analysts Journal published a study in 1993 that found no statistically significant excess return or statistically different performance for socially responsible mutual funds in relation to conventional mutual funds.5 Studies of this nature highlight that sustainable investing is not simply a golden ticket to outperformance. It is worth considering, depending on the approach being used, that there are risks to limiting one’s investment universe with screens and investing with a greater focus on sustainable criteria than on financial data.
3 Edmans, A. (2011). Does the stock market fully value intangibles? Employee satisfaction and equity prices [Abstract]. Journal of Financial Economics, 101(3). doi:10.1016/j. jfineco.2011.03.021
What’s the next step?
Many asset management firms are offering more resources and building out their product offerings in the sustainable investing space. Investment products are also available at Raymond James for implementing sustainable investing. Whether focused on screening, advocacy or more in-depth analysis using ESG criteria, more and more options are arising for clients of all wealth levels. Separately managed accounts (SMAs) can offer an investment strategy targeted to a client’s specific interests, while various mutual funds offer ESG investment objectives that may align with a client’s values and have lower minimum investments. Also, ETFs can offer index-based exposure to companies that have scored well on sustainable investing criteria or ESG ratings.
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