When you invest, your primary goal is probably to build wealth. But you may also want to put your money to work in a way that aligns with your values. That’s where sustainable investing comes in.
Sustainable investing is an investment strategy that aims to have a positive impact on the planet and society while also achieving profits. Read on to learn how sustainable investing works, some examples of sustainable investing and how to build a socially responsible investment portfolio.
What is sustainable investing?
Sustainable investing strives to benefit the environment and humanity through investing while also generating profits.
In general, sustainable investing can encompass a wide spectrum of investment activities that range from traditional finance to philanthropy, according to Jeff Finkelman, chartered financial analyst and managing director of sustainable investments at Fiduciary Trust International.
“It includes simple strategies that seek only to avoid certain industries, such as tobacco or firearms, as well as those that strive to generate positive social or environmental change with investments in renewable energy, affordable housing or any number of other challenging markets in need of capital,” he said.
Sometimes called socially responsible investing or ethical investing, sustainable investing can take a number of forms.
ESG investing
Often, sustainable investing focuses on environmental, social and governance factors, also known as ESG, addressing questions such as:
- Environmental: Is the company taking proactive steps against climate change and resource depletion? Is it improving energy efficiency and using energy from renewable sources? Is it working to minimize pollution and waste and control emissions? Does it comply with environmental regulations?
- Social: Does the company provide a safe workplace and pay fair wages? Are its products safe? Is its leadership diverse? Is the company engaged with the local community? Does it protect customer data?
- Governance: Does the company have an independent and diverse board of directors? Is executive compensation transparent? Does the company make political contributions or engage in lobbying? Are its business practices ethical?
Many ratings agencies, including Fitch Ratings and Moody’s, create various ESG scores that investors can use to evaluate companies.
Sustainable investors often use negative or exclusionary screening to avoid investing in companies that don’t meet certain ESG criteria. Using this approach, an investor may refuse to buy a company’s securities if it scores poorly compared with its peers on ESG factors.
Some investors choose to exclude entire industries from their portfolios. For example, an investor may avoid “sin stocks,” generally defined as businesses that many people consider unethical, such as tobacco, alcohol, firearms, gambling and adult entertainment. Or you may refuse to invest in oil or nuclear energy stocks due to their environmental impact or in private prisons out of social concerns.
Another approach is to use positive screening, also known as a “best-in-class” approach. Essentially, this is when investors look for companies and sectors that rank better on ESG factors than their peers. For instance, an investor may choose to invest only in companies that rank above at least 50% of their peers based on a number of preselected criteria.
While the terms “sustainable investing” and “ESG investing” are often used interchangeably, they’re not quite the same thing. ESG investing is one type of sustainable investing, but there are several other strategies that fall under the sustainable investing umbrella.
Impact investing
Impact investing is where you aim to achieve measurable environmental or social goals while also earning financial returns. For example, many communities in the US are considered food deserts, which means they have little access to fresh, healthy food. Investing in a grocery store or restaurant that provides healthy food in one of these communities would be a form of impact investing. The goal is to measurably improve the nutrition of residents, but you also aim to earn a profit on your investment.
Thematic investing
Another approach is to use thematic funds to invest money in a cause that matters to you. You can find mutual funds and exchange-traded funds that invest around an array of themes, such as women’s leadership, clean energy and global health care. You could also invest in individual companies that are proactively working to address issues you care about.
What makes an investment ‘sustainable’?
There’s no single approach to sustainable investing, but most investors credit the UN with coining the term in 1987.
The UN defined sustainability as “meeting the needs of the present without compromising the ability of future generations to meet their own needs,” in its Brundtland Commission report.
“Sustainable investments are generally those that take account of, if not promote, long-term social, environmental, and economic well-being,” Finkelman said.
Are sustainable investments as profitable as other investments?
One of the big misconceptions about sustainable investing is that it’s less profitable than other investment approaches. The evidence is mixed, though. Some studies suggest that there’s no relationship between sustainability factors and a fund’s performance, while others conclude that sustainable funds perform at least as well as other funds in their peer group.
At the individual company level, there’s evidence that adherence to sustainable principles is good for profits. Researchers at New York University’s Stern School of Business found that sustainability initiatives at corporations are associated with more innovation, and that low carbon strategies were linked to positive financial performance.
Sustainable investments may also be less risky than companies that don’t have a track record of socially responsible practices. For example, a company with a strong commitment to ESG factors are less likely to be at the center of an environmental disaster, a data breach or a fraud case.
Why does sustainable investing matter?
Sustainable investing matters because it helps you build wealth in a way that doesn’t conflict with your conscience. Many people aren’t comfortable investing in companies that they believe have a negative impact on the world. With sustainable investing, you can earn profits while avoiding companies that have a poor track record of hurting the environment or violating human rights. You can also proactively invest in companies and projects that are doing good in the world.
Where do I find sustainable investments?
There are several ways to find sustainable investments, including:
- Using a robo-advisor: Robo-advisors use algorithms to create customized investment portfolios based on your goals and risk tolerance. Some robo-advisors also give you the option of incorporating ESG factors into your investment strategy.
- Your brokerage or a financial website: Many online brokerages and financial websites allow you to search for mutual funds and ETFs based on various criteria, including ESG and sustainability factors.
- Researching individual stocks: Investing in individual stocks is riskier than investing in mutual funds and ETFs. But if you want to buy shares of individual companies, you can use third-party ESG ratings to search for companies with good sustainability practices and read company reports to get more information.
- Financial advisors: In some cases, a financial advisor can help you build a sustainable portfolio that meets your needs. “One of the challenges inherent in building a sustainable portfolio is achieving the right balance between the investor’s sustainability and investment objectives,” Finkelman said. “They are often complementary, but they can sometimes conflict. A financial advisor can help make sure a client has considered all of the potential risks and opportunities that may come from enhancing the sustainability profile of their portfolio.”
What funds are considered sustainable investments?
There were more than 600 mutual funds and ETFs focused on sustainable investments as of 2022, according to US SIF: The Sustainable Investment Forum. Here are just a few examples of sustainable investment funds:
- iShares ESG Screened S&P 500 ETF (XVV): The ETF invests in S&P 500 stocks but excludes companies involved with controversial weapons, small arms, tobacco, oil sands and shale energy, thermal coal, and fossil fuel reserves.
- Vanguard ESG U.S. Stock ETF (ESGV): The fund invests across the US stock market but excludes some types of companies, such as those that produce alcohol, tobacco, weaponry and nonrenewable energy. The index also screens out companies that don’t meet certain labor, human rights, environmental and anti-corruption standards spelled out in the UN Global Compact Principles, as well as those that don’t meet diversity criteria.
- Gabelli Love Our People & Planet Fund (LOPP): This actively managed fund invests in companies committed to sustainable practices like renewable energy, water conservation, waste reduction, and human health and nutrition.
- Fidelity Clean Energy ETF (FRNW): This thematic fund invests in companies that are involved in the production and distribution of renewable energy.
For a more comprehensive list of sustainable funds, you can use your brokerage’s research tools or a financial website to search for funds according to various ESG criteria.
The bottom line
You don’t have to sacrifice profits to invest sustainably. Whether you’re investing in mutual funds or ETFs or individual companies and projects, there are a number of ways to earn profits ethically. You can invest in funds or shares of companies based on whether they adhere to specific ESG criteria, or you can avoid investing in companies whose products and practices conflict with your values. Not only can you feel good about the fact that you’re investing with a conscience, but some evidence suggests sustainable investing produces superior returns, particularly in the long run.
FAQs
You can invest sustainably by investing in ESG mutual funds and ETFs or by investing in companies that have strong ESG scores. You can also avoid companies that rank poorly on ESG criteria or that have a history of unethical practices. Some people choose to avoid certain types of companies altogether, such as those that make tobacco or firearms.
Sustainable investing is a strategy where you aim to have a positive impact on the world. ESG investing and impact investing are two forms of sustainable investing. ESG investors use environmental, social and governance factors to determine whether an investment is sustainable. Impact investing is a strategy where the focus is achieving a measurable goal that benefits the planet or humanity, in addition to earning positive returns.
First, make sure you define your values and what causes you care about, as well as any industries or business practices you consider unethical. If you’re interested in mutual funds and ETFs, look for funds that invest according to the themes that matter to you or that screen out investments that conflict with your values. If you want to invest in individual companies, look at ESG ratings from third-party agencies, as well as those that are investing in projects you believe can have a positive long-term impact on the world.
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