When it comes to investing, you have a lot of options. Whether you’re investing in specific companies, funds, or a combination of both, you have myriad choices for investing in securities. It’s no wonder that building out your portfolio can be daunting. There’s a lot to think about, but one consideration that’s growing in popularity is ethics. How do the companies in which you’re investing align with your values? Do they care about the same things you do? Do they want to make the world a better place?
Seeking out and investing in companies that fit this description is part of a growing trend called “sustainable investing.” But what exactly is sustainable investing, and is it right for you?
What Is Sustainable Investing?
Put simply, it means investing in companies that are working to create a better future. Whether it’s trying to combat climate change, fighting environmental destruction, promoting corporate responsibility, championing social change, or something else, these companies try to leave the world a little better than how they found it.
Sustainable investing is part of the broader trend of values-based investing—or, investing in companies that share your values, whatever they may be. But sustainable investing gets a little more specific. Additionally, sustainable investing can be broken down even further into different subsets, including environmental, social and governance (ESG) investing and socially responsible investing (SRI).
How Does ESG Investing Differ?
ESG investing is a form of sustainable investing that focuses on companies that are actively trying to limit their negative impact on society, benefit society, or both. These investments are graded and given an ESG score, which measures the sustainability of an investment in three specific categories:
- Environmental: What steps is the company taking to preserve the natural world? For instance, what is its stance on topics such as carbon emissions, deforestation, and water usage?
- Social: How does the company treat people—both employees and nonemployees? For example, what are its policies on employee diversity, fair labor practices, and human rights—both abroad and at home?
- Corporate Governance: How is the company run? For instance, how diverse is its governing board, does it do any political lobbying or make political contributions, and is there any internal corruption?
The Sustainability Accounting Standards Board (SASB) aims to standardize the ways companies report on ESG criteria to better inform investors, including determining which ESG issues companies should prioritize based on sector and industry.
What Are the Benefits of ESG Investing?
Sustainable investing is still a relatively new concept, and as such, there’s a lot of debate as to its merits beyond keeping companies on the straight and narrow. However, from an investment perspective, there are three potential benefits that stick out: higher returns, less risk and greater sense of purpose.
There’s still some skepticism over how well sustainable funds perform versus their traditional counterparts, but a recent report from the Morgan Stanley Institute for Sustainable Investing found that sustainable funds clearly outperformed their traditional peers during the coronavirus pandemic of 2020. According to their findings, U.S. sustainable equity funds outperformed their traditional peer funds by a median total return of 4.3 percentage points, while U.S. sustainable bond funds outperformed their traditional peer funds by a median total return of 0.9 percentage points.
The tracking period of this study only covered a relatively brief amount of time, so more data may be necessary for investors to feel more confident in the performance of these funds. But so far, the results are promising.
That same Morgan Stanley report also noted that there was less downside risk when investing in sustainable funds over traditional funds. Of course, there’s always risk involved with any type of investing, but another 2019 white paper from Morgan Stanley that measured the performance of nearly 11,000 mutual funds from 2004 to 2018 also found that sustainable funds experienced a 20% smaller downside deviation than traditional funds. Additionally, the study found that these funds were generally less volatile—even during periods of extreme volatility, which proved consistent with Morgan Stanley’s later findings throughout the 2020 pandemic.
Greater Sense of Purpose
This last benefit is harder to define using data, but it’s an important one. You likely got into ESG investing because you wanted to feel good about the types of funds or companies you were backing. You wanted to invest in companies that have the same values that you do. When you invest in these types of companies, you can feel a sense of purpose knowing that you’re not contributing to a company that’s polluting the air or oceans, is over reliant on fossil fuels, or is holding onto less progressive corporate policies. You can feel confident that these companies are taking steps to do things ethically.
How to Get Started with ESG Investing
More and more companies are adopting ESG practices, so investors looking to build out an ESG portfolio have more options than ever before. But having more options doesn’t necessarily make things easier—especially if you’re a DIY investor. As you build out your portfolio, here are three tips to get started:
1. Determine Your Own ESG Investing Criteria
It’s important to reconcile your own values with those of the available ESG companies or funds. For instance, maybe you’re passionate about the environment but don’t spend as much time thinking about corporate governance. When you’re researching where to direct your investment funds, you’ll likely give more weight to how a company or fund scores in terms of its environmental factors. Before you do any research, set your own criteria to determine how to narrow down your options.
2. Research Where to Invest
Once you’ve narrowed your focus by determining your own criteria, it’s time to do some research to evaluate those companies or funds. Seeking out reviews from an independent research firm like Morningstar can show you how a company or fund scores in terms of ESG investing factors. Additionally, you can research investment performance beyond ESG score by looking at traditional key performance indicators (KPIs) like revenue, price-earnings (P/E) ratio, and return on equity (ROE) and return on assets (ROA).
3. Seek Out Expert Help
Building out a well-balanced, diversified investment portfolio takes time and energy. Sure, you can determine your own criteria and do some research, but staying on top of the markets and evaluating investment performance might be easier said than done. And what happens if you’re looking for expert advice?
You may find that seeking help from an investment or financial advisor ends up being the more prudent decision. Not only will they likely have greater insights into best practices for portfolio makeup and market performance, but they can also provide necessary advice or guidance if you’re unsure of something. And if they’re a registered investment advisor (RIA), you can have confidence knowing the advice they’re giving you is for your benefit—not theirs.
Reach out today to learn more about how the specialists at Wealth Enhancement Group can help you get started building a more ethical, value-based investment portfolio.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
SRI and ESG investing have certain risks based on the fact that the criteria excludes securities of certain issuers for non-financial reasons and, therefore, may forgo some market opportunities and the universe of investments available will be smaller.
CFP®, RICP®, CAP®, MBA, Series 7 Securities Registration,1 Series 66 Advisory Registration,† Insurance License Andrew is a CERTIFIED FINANCIAL PLANNER™ professional and Retirement Income Certified Professional® and Chartered Advisor in Philanthropy® who has been with Wealth Enhancement Group since 2007. His love of learning and for helping others achieve clarity in their financial lives is evident within his approach to thoughtfully...Read More