Sustainable investing is the idea that investors can achieve a positive societal impact with their investments. Optimally, this should be accomplished without sacrificing long-term financial returns. The possibility of achieving these dual objectives is what investors in increasing numbers find attractive. In recent years, a growing number of individual and institutional investors have been adopting sustainable investing strategies. Moreover, the same investor groups anticipate that sustainable investing will become even more important over the next few years. But investors should be aware that the successful implementation of such strategies call for the application of basic investment principles and due diligence.
Sustainable investing can be pursued through a variety of sustainable strategies, but most practitioners agree that these encompass one or more of the following four notable approaches:
- Screening out or excluding companies from investment portfolios for a variety of reasons, including ethical, religious, as well as other strongly held beliefs, such as environmental concerns or involvement on the part of companies in specific business activities, such as gambling and sex related activities, the production or manufacturing of alcohol, tobacco or firearms, or atomic energy. In general, this investment approach, when viewed through the prism of mutual funds, has produced an uneven financial track record.
- Impact investing or investing to achieve a targeted social or environmental objective that is measurable, for example, such as investments in companies that develop or offer products or services seeking to protect the environment or provide environmental solutions intended to reduce greenhouse gas emissions that are widely believed to bring about climate change, or companies that promote workplace diversity, human rights and community relations, advance educational initiatives or attempt to alleviate housing shortages and poverty, to mention just a few.
- Integrating environmental, social and governance (ESG) considerations as a proactive and integral component of the investment research and portfolio construction processes, including companies with social and environmental objectives that some investors believe can serve to minimize certain vulnerabilities, such as the risk of lawsuits from employees or toxic spills, and look for these attributes as predictors of long-term financial performance, and
- Shareholder and bondholder advocacy and engagement in an effort to influence corporate behavior.
These strategies are not mutually exclusive and investors can engage in one or more of these at the same time. Moreover, it’s not always entirely clear where one strategy begins and another ends, as these can also morph into one another. While the above definitions attempt to broadly define sustainable strategies, there are potentially other investing approaches that aim to achieve a positive societal impact and financial returns that might not lend themselves to easy classification. For example, investing in or financing microfinance institutions that seek to provide banking services to poor families and micro-entrepreneurs falls into this category.
Sustainable investing has been gaining a footing among individual investors as well as a wide range of mainstream institutional investors. These include public pension funds, endowments, foundations and insurance companies, to mention just a few, as well as traditional investment management firms. Historically, much of the focus of sustainable investing has been on stock oriented strategies, whether through individual securities or funds. As more investors seek to apply a sustainable approach to their entire portfolio of securities, attention has begun to shift to other asset classes, including fixed income and real estate. This approach in one form or another has also found its way into alternatives, such as hedge funds and private equity portfolios.
Investors can implement sustainable investing strategies by purchasing individual stocks, bonds, mutual funds, Exchange Traded Funds (ETFs), Unit Investment Trusts (UITs) and even closed-end funds. But regardless of the approach, the same basic investment principles apply before a purchase decision is made. That is, investors have to conduct fundamental due diligence and analysis to evaluate the investment to make sure that it fits with their return requirements, risk tolerance, income needs and asset allocation goals. In addition, the investment’s sustainability profile should be aligned with the investor’s goals and objectives. Typically, due diligence efforts should focus on management characteristics and stability of organization, historical performance or financial track record, expenses as well as any other investment specific relevant considerations which will likely vary from one investment to the next.