If there’s a trait most of us share, it’s a desire to make the world a better place. That is why there is increasing interest in sustainable investing. Many of us want to try to earn solid or even stellar returns while contributing – or at least causing less harm – to the greater good.
But what is the greater good? What is a decent return on your investment? How do we make it happen? Financial history leaves us optimistic that, over time, best practices are likely to emerge out of the bubbling cauldron of turmoil that is our capital markets.
As a relatively new and fast-growing field, sustainable investing (often called Socially Responsible Investing or “SRI,” or Environmental, Social and Governance or “ESG”) is crowded with opportunities and challenges, differing perspectives and priorities, strategies and terminology.
As we think about integrating subjective values into objective financial planning, we are inspired by “Doing Good Better” author William MacAskill: “I believe that by combining the heart and the head – by applying data and reason to altruistic acts – we can turn our good intentions into astonishingly good outcomes.”
Of course we do not direct anyone’s personal moral compass. Rather, for those interested, we offer opportunities, objective insights, rooted in our evidence-based investment approach. An evidence-based outlook helps confirm when a theory appears to be actually robust in reality. It also suggests when a promising plan may not turn out as hoped for – no matter how well-intended it may be.
Equipped with solid evidence in an often emotionally charged arena, we are better positioned to make the rational choices and informed decisions that best fit you, your heartfelt values, and your financial goals.
A Tangle of Terminology
- Financial Priorities – Some investors may not be as interested in investing “morally,” but may do so anyway if they expect to earn higher returns from stronger-performing companies.
- Impact Priorities – Other investors may not care whether sustainable investing brings higher expected returns, as long as they can shun “bad” companies and/or invest in “good” ones.
- Blended Priorities – Most investors fall somewhere in between: They want to earn solid returns (or at least not lose money) while investing in principled ways.
First things first. While there are many terms sharing similar definitions in this crowded field, we’ll refer to the broad subject as “sustainable investing.”
Call it what you will, recent research has found that different investors embrace sustainable investing for different reasons. Your own priorities govern the type of sustainable investing that should best align with your personal goals:
Degrees of “Doing Good”
The value of the different kinds of “doing good” are often in the eye of the beholder. How do we measure something that is sometimes so subjective? As described in “Why and How Investors Use ESG Information” (a University of Oxford/Harvard University paper to be published in the Financial Analysts Journal), academics and practitioners alike typically turn to an organization’s Environmental, Social and Governance (ESG) ratings to try to quantify levels of sustainability.
Again, precise labels may vary, but following are some of the ways the industry applies ESG ratings into sustainable investment strategies.
- Active Ownership – Employing “shareholder power” to try to actively improve a company’s ESG performance (engaging senior management, submitting proposals, proxy voting, etc.)
- Negative Screening – Explicitly excluding firms with low ESG ratings (“This company is too ‘wicked’ to belong in my portfolio.”)
- Positive Screening – Explicitly including firms with high ESG ratings (“This company is at least ‘good enough’ to belong in my portfolio.”)
- Inclusion Strategies – Integrating ESG data into existing evidence-based analyses, melding the information into a systematic, total portfolio management strategy
There are currently a range of investment solutions that incorporate these and other strategies to varying degrees:
ESG Investing – ESG investors are more likely to emphasize inclusion strategies, which complement a general evidence-based investment approach. In other words, evidence-based ESG funds should help investors continue to incorporate sound portfolio construction principles (such as asset allocation, global diversification and cost control), and minimize less-efficient tactics (such as picking or avoiding specific stocks or sectors based on forecasts or popular appeal). ESG fund managers also may engage in active ownership on behalf of their shareholders.
Socially Responsible Investing (SRI) – SRI funds are more likely to use screening strategies that involve making security- or sector-specific judgments or forecasts.
Impact Investing – Impact investors are on a mission to not just invest in a venture, but to become an altruistic partner in it. Say, for example, you donate to a GoFundMe campaign seeking to create an eco-friendly alternative to plastic water bottles. You’ve just become an impact investor. On a grander scale, other investors may take on private equity or debt structures with an eye toward making an impact with their funding.
Finding a Sustainable Fit
None of these possibilities are inherently right or wrong. Which (if any) are right for you? As proposed in the innovative paper, Sustainable Investing: From Niche to Normal,” it depends whether you are more value– or values-driven. The paper explains that value-driven investors “put financial return first, BEFORE any other issues are addressed,” while values-driven investors will “consider financial return AFTER the investors’ values have been satisfied.” Both of these goals are legitimate and worthwhile. So in this context:
- ESG investing focuses more heavily on value – i.e., financial outcomes – factoring in ESG ratings when the evidence suggests they might improve on expected returns (or at least not detract from them).
- Impact investing seeks to fund a cause with less regard for how the “investment” works out. Hint: If you’re mostly in it for the money, you might not be in the right place.
- SRI investing falls somewhere in between. You don’t want to lose your shirt, but you may not mind giving up some expected return if you expect it to do a lot of good.
Sustainable investment strategies aren’t mutually exclusive either. For example, you could incorporate ESG investing into the core of your portfolio, while also participating in impact investing.
We’ll look again at sustainable investing in December, and discuss the evolving landscape and look at solutions coming into focus. Challenges and opportunities abound as we seek to create robust data and enhanced analyses to guide the way – in theory and in practice.