Sustainable Investing

Sustainable investing is a way for businesses and investors to positively impact their environment and communities while also profiting, at least that’s the idea. However, sustainable investing is a long-term proposition, and it may take some time for its impact to manifest in positive returns whether financial or environmental.
This article will explain what sustainable investing is and how it differs from environmental, social, and governance (ESG) investing or green investing. It will explain the advantages and disadvantages of incorporating sustainable investing into a stock portfolio, how to do it, and what the future looks like for sustainable investors and the companies they support.

What Is Sustainable Investing?

Sustainable investing is often conflated with environmental, social, and governance (ESG) investing, but they are not quite the same. Sustainable investing is a broad term that has components of socially responsible investing, ESG, and green investing; all three fall under the umbrella of sustainable investing. An example of sustainable investing is ownership in a clean technology company or a community development loan fund.

Socially responsible investing (SRI) is an investing strategy that screens companies and excludes them based on screening for criteria. For example, whether the company supports tobacco cultivation or weapons manufacturing. Alternatively, a company might be included in a portfolio if it focuses on reducing greenhouse gas emissions.

ESG involves a broader approach to building a portfolio that balances responsible investing with risk. For example, investors might weigh how a company’s ESG factors affect its performance.

Green investing excludes companies in the same way that SRI does but focuses specifically on the protection of natural resources. Companies researching renewable energy would be a target for green investors.

History of Sustainable Investing

The philosophy behind sustainable investing is not a new one. In the 18th century, the Methodist Church and the Quakers frowned upon investments in the “so-called” sin stocks—alcohol, tobacco, weapons, and gambling. In 1928, the Quakers created the first publicly offered SRI Fund, Fidelity Mutual Trust.

The exclusionary approach to investing continued to grow throughout the decades. Then, the creation of the United Nations and the International Declaration on Human Rights in 1948 brought sharper focus to sustainable development. Objections to the Vietnam War resulted in boycotts of weapons manufacturers and defense contractors, while the civil rights movement bolstered ESG investment. In the 1970s, the focus shifted from social to environmental issues, and the first Earth Day Celebration was held in April 1970.

In the 1980s, apartheid in South Africa caused many investors to divest themselves from South African investments. Then, the tragic Chornobyl disaster and Exxon Valdez oil spill pre-empted the creation of the United States Sustainable Investment Forum (US SIF) and the Coalition for Environmentally Responsible Economies (CERES).

Sustainable investing has and continues to be a growing movement. According to the Global Sustainable Investment Review 2020, assets under management for sustainable investing at the beginning of 2020 were $35.3 trillion and have grown by 15% since 2019. Also, sustainable investment assets under management comprise over a third of total global assets under management. While they can’t claim to be at the forefront of sustainable investing, Canada and the United States saw the most growth in sustainable investing at 48% and 42%, respectively, in the last two years.

What Is the Attraction of Sustainable Investing?

The attraction of sustainable investing is that companies that want to stay competitive don’t have much choice but to follow sustainable practices. According to a report by PwC, a growing number of studies show that companies with strong ESG credentials outperform those with weaker ESG credentials.

Competitive Advantage

Companies that take a sustainable approach to the environment have advantages. Their business practices engender goodwill from the public, other companies, potential partners, and employees. This means they are better positioned to leverage partnerships and gain visibility. They also improve their reputation, which makes them more attractive to talented job seekers. All these factors improve business and productivity.

Longevity

Sustainable investing is a long-term proposition, which means that companies must develop a long-term, sustainable plan for growth. This requires investment in R&D and finding ways to protect the environment, reduce fossil fuel use, and develop renewable energy. Otherwise, climate change portends that there will not be a world to do business in.

It seems obvious then that firms that plan for the short term and pursue destructive policies will limit future profits. For example, a logging firm that does not replant trees will run out of trees, and banks that lend to subprime borrowers who are forced to default will not see their expected returns.

What Are the Pros and Cons of Investing in Sustainable Investments vs. Pure Growth Investments?

The cons of sustainable investing are the uncertainties associated with a long-term strategy and the difficulty in measuring the real impact of sustainable practices. One pro of sustainable investing is that it is a growing sector with plenty of innovations that could produce returns over time.

The Disadvantages of Sustainable Investing

The disadvantages of sustainable investing include the difficulty investors have in discerning a company’s real impact. Often, a company’s claims cannot be substantiated. Companies often tout their impressive green or ESG ambitions but fail to demonstrate real progress through its operations. This behavior is known as green washing. A persistent problem is the lack of rating standards and systems, so companies cannot be measured or compared in terms of their sustainable agendas.

One of the most recent examples of green washing involves Goldman Sachs’ asset management division and some of its ESG-themed investment funds. BYN Mellon was also recently accused of green washing, and the CEO of Deutsche Bank’s investment arm, DWS, recently resigned after greenwashing allegations came to light.

Another disadvantage for investors is that in-depth research on a firm is needed to discern what practices they follow to decide whether to invest in them or not. For example, a firm might be fulfilling its obligations in one area, let’s say, reducing carbon emissions, but failing to do so in another, like ensuring equal pay for its employees. Should that company be included in a sustainable investing portfolio?

Lastly, some critics point to the lack of diversity offered by ESG shares. Most ESG companies are large-cap stocks, so an ESG investor would have limited exposure to small and mid-size stocks. Also, some ESG mutual funds and ETFs exclude certain industries—oil and weapons manufacturers, for example, further reducing diversification.

The Advantages of Sustainable Investing

Sustainable investing allows the investor to align their financial strategy with their values. Investors can influence the causes they are concerned with, whether climate change or social inclusion. Also, because a sustainable investing strategy assumes a long-term position, it is more likely to produce returns over time. In many cases, companies that integrate green or ESG initiatives into their business strategy are more innovative, which makes them a better bet.

Most interestingly, sustainable investing seems to be a growing industry with evidence of tangible returns. Particularly where green investing is concerned, its nascency means that it is largely untapped with the potential for significant returns.

How Can Novice Investors Start Sustainable Investing?

Novice investors should learn as much as they can about sustainable investing, new ESG-related technology, and social trends. It will be time-consuming, but pouring over company annual reports and social responsibility reports will give a broad overview of the sustainability landscape. From there, investors can zero in on any companies, trends, or initiatives that strike them as notable and build a strong portfolio.

Distinguish Between Hype and Reality

There’s a lot of hype about break-through innovations, so it’s wise to do your homework to find out what has potential and what does not. Some sustainable initiatives will find it difficult to gain traction because they are expensive. Increased competition is also a problem.

The bamboo fork vs. the plastic fork is a good example. Creating the sustainable bamboo fork is expensive. It takes more time and resources than a plastic fork, such as biodegradable materials for packaging. Also, a responsible company would want to pay its workers equitably, further adding to the costs. Thus, a company that makes bamboo forks may be biting off more than it can chew, pun intended, because consumers will not be willing to pay the extra cost.

Study Annual Reports

A company’s annual report will often reveal new concepts and ideas, but others will copy a company at the forefront of sustainable investing. Use all the information at your disposal to identify and track sustainable strategies and inform your choice of assets.

Study Corporate Social Responsibility Reports

A growing number of companies voluntarily disclose their sustainability efforts. They achieve this through organizations like the Global Reporting Initiative (GRI) or the Carbon Disclosure Project.

The GRI has developed reporting standards for companies engaged in sustainable initiatives. The Carbon Disclosure Project is a not-for-profit charity that runs a global disclosure system. These are valuable sources for investors to learn more about companies and their activities.

What Are the Risks with Sustainable Investing?

No investment strategy is risk-free, but sustainable investing with a diverse portfolio may be one of the best for the risk averse. That said, here are some of the problem areas associated with sustainable investing.

Sustainable Investing Is a Fad

Some critics consider sustainable investing a fad. Such critics consider it a product of a robust economy and predict that priorities will change when the economic landscape spoils.

The Cost for Companies

Companies that produce sustainably face many more costs. This includes having to pay higher wages. They also have to adhere to strict rules to earn sustainable certifications like organic and fairtrade.

Companies may consider a sustainable approach low priority because of the extra costs involved. They assume a “What is in it for me?” attitude. Many sustainable products and services are not yet in high demand. Companies cannot mass produce them to take advantage of economies of scale. Also, the cost of sustainable raw materials is often higher than the traditional raw materials.

According to the Minimalist Vegan, “using recycled paper instead of virgin paper saves trees but recycling the paper costs more than cutting down new trees and using them for pulp.”

What Is the Difference Between Sustainable and Green Investing?

Sustainable investing is a blanket term encapsulating all progressive investing strategies—ESG, SRI, and green investing. It signifies that a company is trying to “do better”. This will be in areas of environmental protection, economic growth, and social progress. Through sustainable investing, companies gain access to capital to drive their strategies. These strategies will include elements to fight climate risk and promote corporate responsibility.

What is the Criticism with Sustainable Investing?

Critics of sustainable investing point to the lack of clarity that surrounds both its financing and its impact.

Firms must pay out increasing amounts of money to comply with new policies, rules, and regulations. Meanwhile, governments are not being held accountable, and it’s unclear how public funds are being spent.

In the United Kingdom, businesses that produce packaging or sell packaged goods must comply with specific regulations. These require them to complete a recovery and recycling obligation and submit a certificate of compliance. Companies also must pay a landfill tax for any waste disposed of by landfill. They do receive tax credits for recovering and recycling efforts.

In the United States, companies can receive tax credits and incentives. Before receiving these, they must first invest in electric vehicles, renewable energy and green fuels. This also includes upgrades to energy efficiency in commercial buildings. Going green does not come cheap.

Another criticism is the lack of metrics and standards to measure the impact of sustainable companies. This is also useful to make comparisons when setting investment strategies. Things are slowly changing, however. In the United States, the Sustainability Accounting Standards Board (SASB) created industry metrics that track the impact of environmental issues among companies by industry, and the UN Sustainable Development Goals, created in 2015, are used as progress indicators.

However, investors are still kept largely in the dark by the lack of standardization of disclosures. ESG disclosures remain voluntary, and any disclosures are not standardized.

5 Tips for Profiting from Sustainable Investing

Here are five tips for profiting from a sustainable investment strategy.

Find Sustainable Funds

Do your research and learn as much as you can about companies before you invest in them. Watch out for green washing because companies without authenticity will not sustain their value. Follow the news closely and subscribe to trade publications. Study sustainability ratings and scores, such as those provided by MSCI, Vigeo Eiris, ISS, and RobecoSAM. For investors, ESG rating information is also available for free at sites like Sustainalytics and CSR Hub.

Don’t be Dollar-Struck

Beware of isolated numbers. For example, an energy company might pledge to commit $8 billion a year towards green alternatives. However, they might also plan to continue investing $60 billion over the next five years in oil and gas. This is green washing.

Target a Variety of Industries

A specific industry or group may be a focus of your sustainable investment goals. Perhaps you want to champion renewable energy and invest in wind power. However, if the wind energy sector experiences problems, you could lose your investment. Diversify your portfolio by spreading your money across different assets, industries, and geographies to reduce your risk. Consider investing in sustainable mutual funds and ETFs.

Look at Performance Not Just Sustainability

Do not forget profit! Do your research and check for trends that have potential. Look at the fundamentals of a company and then look at their sustainability impact. Of course, if you want to take a risk on a wild card, that’s up to you. But remember the golden rule, which is do not invest more than you can afford to lose.

Monitor Your Portfolio

You should set up a trading strategy and one that you plan to stick with. However, also plan to monitor your investments on a monthly or quarterly basis. Give returns time to come through. Sustainable companies that are innovating will need time to establish themselves. Be prepared to walk away if companies are not performing.

Sustainable Investing: General Terminology

Carbon footprint – A group, company, or individual’s total greenhouse gas emissions.

Carbon pricing – The cost of emitting CO2 into the atmosphere in terms of a fee per tonne or incentives to emit less.

Clean technology – Products and processes that use fewer natural resources and reduce CO2 emission and waste.

COP – Conference of the Parties. The decision-making body of the UN Convention on Climate Change (UNFCC). The body meets annually to set policies.

Corporate responsibility – A company’s responsibility to operate its business in a sustainable way that does not harm the environment or society.

Ethical investing – Investing according to your ethical principles and values and excluding companies that do not align with those values.

Green bond – Bonds that fund sustainable projects, such as renewable energy.

Green washing – Claiming to have an impact on the environment or natural resource use but without providing evidence.

Impact investing – Investments that support environmentally and socially sustainable projects while also giving a financial return.

Paris Agreement – A global commitment agreement among countries to limit global warming to below 2°C, agreed at COP 21 in Paris in 2015.

Responsible Investing – Investing with consideration of ESG or green issues.

Screening – Pre-screening companies based on their sustainable activities (or lack of them) to include or exclude them in an investment strategy.

Conclusion

Sustainable investing is a growing trend, but not a passing one. There is increasing pressure on companies to engage in ESG and green initiatives. There are also many benefits for them if they do so. Companies that integrate ESG and green activities attract capital, improve their reputation, gain competitiveness. This creates innovation, attracts talent, and means they can receive government-backed financial incentives.

For the investor, the sustainable investing approach is still young, and there is a largely untapped market. However, a problem for investors is separating the wheat from the chaff. As governments introduce regulations and policies, the fog should begin to clear. For now, sustainable investing is a viable option for long-term investors.

FAQs

What is meant by sustainable investments?

Sustainable investments are investments that try to kill two birds with one stone. They aim to benefit the environment, society, or the world in some way while also yielding a return. Sustainable investing incorporates components of SRI, ESG, and green investing.

What are examples of sustainable investments?

Examples of sustainable investing are contributing to clean technology companies, renewable energy generation, or community development loan funds.

How should you assess an investments sustainable compatibility?

To align your sustainability goals with your investment goals, do your research and choose the right assets. Read as much as you about the company or fund that you are targeting. Pour over annual reports and check sustainability ratings. This will reveal if there is evidence that there is a measurable impact or if green washing is suspected. Try to diversify your portfolio rather than focusing on one area to reduce your risk.

What is the future of sustainable investing?

Sustainable investing is only going to continue to grow. It amounts to a long-term strategy to both improve the world, its communities, the environment, and to build wealth for the investor. In that regard, investors and companies are aligned. Companies and governments are under increasing pressure to change their operation models to support the world. Hence, the wise sustainable investor seeks new trends and innovations that will stand the test of time.

Which countries are at the forefront of sustainable investing?

According to Morningstar’s Sustainability Atlas, the Netherlands is the world’s most sustainable stock market. France is second after Sweden and Finland. Hong Kong ranks fourth and is the most sustainable non-European market. Taiwan is fifth. The weakest performers are several Middle Eastern, Latin American, and Eastern European emerging markets, including Russia and Brazil. The United States ranks 13th out of 48, and the United Kingdom ranks 15th out of 48.