A Guide to Sustainable Investing

Sustainable investing is an investment strategy which seeks to consider both financial return and social and environmental good to bring about social change.

What is Sustainable Investing?

Sustainable investing is an investment strategy which seeks to consider both financial return and social and environmental good to bring about social change. Socially Responsible Investing, ESG, and Impact Investing are each sub-strategies of sustainable investing. While ESG is typically used as a generic term by investors to refer to sustainable investing, ESG is actually a specific subset of non-financial performance indicators. These include sustainable, ethical, and corporate governance issues such as managing a company’s carbon footprint and ensuring there are systems in place to ensure accountability.

SRI vs ESG vs Impact

Socially Responsible Investing started in the 1970s as investors used screening methods to exclude investments in guns, tobacco, gambling, and other vices. ESG is its own class of investing that integrates environmental, social, and governance factors into the fundamental investment process. Impact investing is less focused on returns and more focused on intent. With impact investing, investors make investments in market segments dedicated to solving pressing problems around the globe. These sectors could include those making advancements in green and renewable energy, housing equity, healthcare access and affordability and more.

ESG Factors

ESG investing incorporates several factors into the fundamental investing process. These include environmental components such as climate change policies, carbon footprint, waste disposal, and usage of renewable energy. It also includes social components such as employee treatment and pay, diversity and inclusion, ethical supply chain sourcing, and public stance on social justice issues. Corporate governance is also a major factor, which includes executive compensation, diversity of the board, and proxy access.

Sustainable Investment Strategies

SRI generally uses exclusionary screens or filters to exclude companies that do not meet particular value criteria. Shareholder activism is another form of SRI investing in which investors buy shares of a company in order to engage with the company to encourage or demand improvement.

Impact investors put their money in companies that have demonstrably positive environmental and social impacts, on top of financial returns. A financial outcome that matches or beats the index return is not the benchmark used to measure success. Rather, the aim is to see progress in a desired area, by tracking indicative metrics.

ESG investors on the other hand actively opt in to companies because of impressive environmental, social, and governance attributes. ESG offers more flexibility and depth of research than a traditional SRI filter. ESG focuses on companies’ material issues that impact their financial situations. A distasteful industry can yield a high ESG company. For example, a defense company specializing in missile production and scores high on environmental sustainability, employee treatment, and corporate governance may merit inclusion in an ESG fund, but a traditional SRI investor would steer clear.

Sustainability Assessment

Several respected sustainability standards have been set such as Global Reporting Initiative (GRI) and Principles for Responsible Investment (PRI). Company websites may provide an insight into companies’ sustainability goals, but concrete data and statistics are more difficult to come by.

The Future of ESG Investing

During former President Trump’s tenure, a new rule was implemented regarding ESG investing in employer retirement plans. The rule essentially required employers to only consider factors like risk and return when selecting investments. This meant characteristics like social or environmental good could not be used as a deciding factor for investments. In addition, rules also currently do not allow ESG funds to be used for auto-enrollment. The Biden administration has recently announced that it will be reviewing these rules and in the meantime will not enforce the previous guidance. ESG investments already captured $51 billion of net new money in 2020, a 5th consecutive annual record and more than double the prior year. It is likely that this new guidance will look to expand ESG investing, particularly in retirement plans.