Investing involves risk-taking. Investors rank financial performance very highly when considering investment opportunities. Thus, during market research, the investor considers their risk tolerance against the possible returns they could get from any proposed venture. If the outcome and returns outweigh the risks, the investor will most likely explore that option.
However, a new model of investing is emerging. Here, profit-making is not at the top of the investment objectives. Rather, the investor considers the societal impact and relevance of their investment efforts. This sort of investing is known as sustainable investing.
Research suggests that many people consider sustainable investing important these days. Companies now set aside a portion of their funds (known as sustainable funds) to be channeled towards socially relevant projects. Additionally, many people are placing ESG (Environmental, Social, and Governance) factors high on their list of investment objectives.
If you are about to start investing and are looking for a way to make a societal impact while making a profit simultaneously, then sustainable investing is for you. So, exactly what is sustainable investing? And is it the right investment choice for you? Let’s take a closer look at this investment type so you can learn everything you need to know about sustainable investing.
What is Sustainable Investing?
Sustainable investing incorporates environmental, social, and governance (ESG) factors when investing or considering investment options. Sustainable investing refers to direct investment in companies and businesses that seek to provide sustainable development. Sustainable investments can be in different fields, although the commonest areas usually involve environmental preservation and the combatting of climate change. Sustainable investors are thus more likely to invest in companies that fight carbon emissions or otherwise engaged in efforts to counter the ravages of climate change.
This sort of investing allows the investor to tie their personal finance to their values. Thus, an average investor here looks to make an impact with their investment, alongside getting financial returns in the process.
Sustainable investing is commonly referred to as the next stage in the evolutionary process of investing. Thus, in the past, sustainable investors often did not place a lot of premium on making a profit. This was because most individual investors negatively screened companies before investing. This then meant sacrificing profits for impact in a way to manage risk.
However, at the moment, a lot of firms are towing the path of sustainable investing. Fund companies are beginning to set apart a portion of their funds into sustainable and responsible investment. Furthermore, the emergence of the coronavirus pandemic has forced many individuals and businesses to look inwards. Thus, there is a greater imperative to preserve the environment and maintain biodiversity. All of these have combined to make sustainable investing quite lucrative at the moment.
What are ESG Factors?
Sustainable investing is oftentimes also referred to as ESG investing. Ideally, a sustainable investor takes cognizance of ESG factors when deciding how to navigate the investment industry. What then are ESG factors? ESG stands for Environmental, Societal, and Governance Factors.
Environmental factors consider a company’s commitment to environmentally friendly projects. Here you typically find high prioritization of projects that protect the environment. Using this metric, a potential investor examines a company’s use of natural resources. Thus, the investor may consider energy conservation efforts, treatment of animals, pollution index, etc. The sustainable investor may also be interested in how the company is managing these risks. Generally, no company is ever immune from engaging in environmentally harmful activities. The decider is usually how the company is working to eliminate the risks as far as possible.
This examines the sustainable practices that impact society directly. For example, a company’s positive social impact can be measured by considering its corporate political contribution to host communities. Hence, the investor can consider the company’s attitude towards corporate responsibility, if the company carries out developmental projects in these communities, whether there is an exchange of traded funds such that the host communities benefit, and even how much pro bono work employees make out time for. Thus, the social criteria of the ESG factors are quite broad.
Governance factors consider the internal mechanisms employed by the company. Thus, the investor may examine whether the selected companies use appropriate accounting methods, comply with government regulations and pay taxes when due. Additionally, the company’s internal structure, including issues relating to board diversity, shareholders’ voting rights, and conflict resolution mechanisms, also come into play.
It is often impossible for companies to perform excellently on all of the factors. Therefore, even though tobacco companies may not do so well in terms of the environment, they may pass the social impact test. Thus, investors have to decide what factors to prioritize. As an investor, you have to carry out thorough ESG research before choosing a company to invest in. First, make a shortlist, then apply market research, focusing on any firm that shows legitimate interest in any of the ESG factors you prioritize.
Terms Associated with Sustainable Investing
There has been a lot of confusion regarding the exact definition of sustainable investing. This is because individual investors often have their own definitions of the concept. Additionally, several other concepts have striking similarities with sustainable investing. Here are some of them:
Screened investing occurs when an investor decides on certain parameters to invest and eliminates companies or businesses based on that. For instance, an investor could only be interested in companies with board diversity.
Ethical investing is an offshoot of screened investing. Here, the investor negatively screens out investment options they consider unethical. What the person considers ethical depends on their values. Thus, this is also known as values-based investing.
Most times, what people consider unethical coincide with what they consider immoral. It is thus the origin of the sin stocks idea. Sin stocks refer to stocks in companies and businesses that produce items or sponsor activities that most people consider immoral. It also includes companies that engage in activities that have a negative environmental impact. Thus, businesses that produce alcohol, are into weapon manufacturing, or mine minerals all have sin stocks.
Impact investing refers to the process of investing in areas where the social or environmental impact of the investment can be measured. The UN’s Sustainable Development Goals serve as a guide for the Global Impact Investing network of investors. There are 17 of those goals, and they represent the biggest challenges that the world is facing. Thus, an investor makes their investment decisions focusing on one or several of those goals and then measures how well they are doing based on the outcomes.
Impact investing is not the same as making charitable donations. In the latter, the donor does not expect any profit. However, in impact investing, asset owners impact the society or the environment while making some profits as well.
Here, instead of having a specific field to invest in, the investor has a general theme they work with. As you must realize, this is similar to screened investing and ethical investing. This is because the personal data of the investor – preference, likes, and dislikes – come into play. Thus, for instance, an investor who wants to focus on sustainable energy will only consider businesses that have products that are not harmful to the environment.
Sustainable Investing Strategies
There are basically two broad sustainable investing strategies. They are ESG incorporation and investor engagement.
ESG Incorporation refers to the process of incorporating environmental, social, and governance factors into the investment framework. We had earlier looked at the different headings under the ESG factors. As a sustainable investing strategy, ESG incorporation includes several subcategories.
The first is positive screening. This involves selecting and investing in companies that have shown a positive ESG index over time. However, this also means that to engage in socially responsible investing, the investor has to screen out companies that aren’t doing so favorably.
Furthermore, there is exclusionary screening. This is the exclusion of companies and businesses that do not meet the standards.
In addition, there is themed investing. As discussed earlier, it involves deploying sustainable investing strategies in specific themed areas.
Finally, there is impact investing, which is the sort of sustainable investing that prioritizes positive environmental and societal impact above all else.
Investor Engagement/Shareholder Resolutions
This refers to the actions of investors and shareholders, which ultimately culminate in sustainable development.
In shareholder resolutions, stock owners and shareholders deliberately take resolutions that are socially meaningful. These resolutions and decisions typically concern such areas and address issues such as climate change, political upheavals, and human rights. In situations like this, these shareholders should already have individual focus on sustainable development. It thereafter becomes evident when they initiate and execute resolutions.
Engagement, on the other hand, concerns investors who may not be shareholders or have voting rights. However, these investors will also have to actively seek sustainable investing strategies. Instead of resolutions, engagements can be in the form of votes, secret balloting, and interfacing with management directly.
The two strategies should culminate in either the company or individual investing sustainably or implementing strategies that promote sustainable investing in the future. Thus, in taking investment advice, the individual investor or the company does not consider just the immediate possibilities of financial profit. Instead, they consider posterity and the benefits companies might enjoy in the future.
Drivers of Socially Responsible Investing
As mentioned earlier, sustainable investing is a huge investment pathway in recent times. So what is the fascination with it, and why is it considered important for today’s world?
The Rise of Millenial Investors
Investment professionals have linked the rise of millennial investors to the increased interest in sustainable investing. This is further tied to the fact that more millennials are either coming into wealth through inheritance or are making big bucks of their own.
Millennials have historically been at the forefront of seeking sustainable development. Hence, it is only natural that they channel the same energy into investments once they had the chance. On record, wealthy millennials are more likely to take investment decisions that tie in with socially responsible investing than any other generation.
Apart from being at the forefront of sustainable investing, millennials also make up the bulk of customers most likely to incorporate sustainable development tenets into their consumer behavior. Hence, a large percentage of millennials are more likely to purchase items from a sustainable brand than non-Millenials, and more than 15% of millennials will desist from investing in a company if they find that the firm implements objectionable practices.
The net effect of all of these is that sustainable investment has become hugely popular and acceptable.
Benefits to Firms
Sustainable investing is getting a huge buy-in from firms also because of the benefits they enjoy. For instance, it introduces an entirely new asset class that is appealing to customers. Additionally, with the rise in interest in sustainable investing, firms who champion societally relevant ideals position themselves to target these crops of investors. Finally, firms benefit because providing sustainable investing products which clients can support eventually leads to better-satisfied customers. This benefits the companies because satisfied clients are much more willing to spend sustainable funds on areas they find interesting.
Due to the benefits sustainable investing affords firms, they are more likely to suggest the path to those looking for viable options.
Gone are the days when sustainable investing was taken not to be profitable. At the moment, not only has the available sustainable investing funds grown, but the returns from investing in sustainable development products and companies have continued to rise too. A crucial part of wealth management involves selecting the best companies and assets. Since sustainable investing currently outperforms many other investment options, investors are thus flocking to it.
How to Get Into Sustainable Investing
Here are three great steps to take when considering going into sustainable investing.
Consider Your Goals
Investors are often keen on investment analysis. However, for sustainable investors, personal values are the chief criterion that informs how and where they choose to invest. Therefore, you need to decide on your investment goals from the start.
Draw Up a List of Companies
The next step after looking at your goals is to decide on the companies that best fit. As mentioned earlier, no company can rank excellently across the three ESG considerations. Zero in on the factor (s) that you cannot compromise and choose companies that rank highly there.
Use a Mutual Fund or ETFs
Mutual funds and ETFs (Exchange Traded Funds) are the two most used options in sustainable investing. They give enough flexibility to hedge your risk and also provide excellent returns as well. After deciding on your goals and the companies to invest in, consider using mutual funds or ETFs.