You might have heard about “sustainable investing.” But if you’re not familiar with it, you might have some questions. For example:
• What does it involve?
• Is it right for me?
• Can I follow a sustainable investing strategy and still get the portfolio performance I need to reach my goals?
Sustainable investing can be defined in different ways, with different terminologies. However, one way to look at a sustainable approach is by thinking of it as investing in a socially conscious way which may involve two broad categories: environmental, social and governance investing and values-based investing.
As its name suggests, ESG investing incorporates a broad range of environmental, social and governance risks and opportunities, along with traditional financial measures, when making investment decisions. This approach may have a neutral impact on performance because it maintains a focus on managing risk, traditional fundamental analysis and diversification. Here’s a quick look at the ESG elements:
• Environmental – Companies might work to reduce carbon emissions, invest in renewable energy, decrease pollution and conserve water resources.
• Social – A business might promote gender and pay equality within its workforce, and maintain positive labor relations and safe working conditions for employees.
• Governance – Companies distinguished by good governance may institute strong ethics policies, provide transparent financial reporting and set policies to ensure it has an independent, objective board of directors.
You can pursue an ESG investing approach through individual stocks, mutual funds or exchange-traded funds, which hold a variety of investments similar to mutual funds but are generally passively managed – that is, they do little or no trading. As an ESG investor, you don’t necessarily have to sacrifice performance because ESG investments generally fare about as well as the wider investment universe. Some investments may even gain from the ESG approach. For example, a company that invests in renewable energy may benefit from the move away from fossil fuel sources.
Now, let’s move on to values-based investing. When you follow a values-based approach, you can focus on specific themes where you may choose to include or exclude certain types of investments that align with your personal values.
So, you could refrain from investing in segments of the market, such as tobacco or firearms, or in companies that engage in certain business practices, such as animal testing. On the other hand, you could actively seek out investments that align with your values. For instance, if you’re interested in climate change, you could invest in a mutual fund or ETF that contains companies in the solar or clean energy industries.
One potential limitation of values-based investing is that it may decrease the diversification of your portfolio and lead to materially lower returns due to narrowly focused investments, prioritization of non-financial goals and too many exclusions.
Ultimately, if you choose to include a sustainable investing approach, you will want – as you do in any investing scenario – to choose those investments that are suitable for your goals, risk tolerance and time horizon.
If sustainable investing interests you, give it some thought – you may find it rewarding to match your money with your beliefs.