If there’s one trait most of us share, it’s a desire to make the world a better place. No wonder there’s so much interest in sustainable investing. Who wouldn’t want to try to earn decent if not stellar returns, while contributing – or at least causing less harm – to the greater good?
But is this a new and better way to invest for the greater good or just another marketing ploy from failed active managers trying to put lipstick on a pig? Financial history leaves us optimistic that, over time, best practices are likely to emerge out of the bubbling brew that is our capital markets. For those who would rather not wait, it can be hard to identify a clear path forward. As a relatively new and fast-growing field, sustainable investing is crowded with opportunities and challenges, perspectives and priorities, strategies and terminology.
Let’s bring today’s sustainable investing into tighter focus.
As we grapple with 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.”
Let’s be clear: We are NOT here to direct your personal moral compass. Rather, we’d like to offer objective insights, rooted in our evidence-based investment approach. An evidence-based outlook helps confirm when a theory appears to be robust in reality. It also suggests when a promising plan may not pencil out as hoped for – no matter how well-intended.
Equipped with solid evidence in an often emotionally charged arena, you will be 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
First things first. While you’re likely to find various terms sharing similar definitions in this crowded field, we’ll refer to the broad subject as “sustainable investing.”
How do we measure something that is sometimes so subjective that are often in the eye of the beholder? 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 in the various literature, 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
Investors currently have access to 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) Investing – 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, high-net-worth 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 this 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.”
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.
The Lay of the Sustainable Land
Before sustainable investing existed, investors who were philanthropically inclined had little choice but to seek their financial returns through traditional investing, while separately expressing their personal values by donating to their charities of choice.
Today, solutions are coming into focus for those who would like to begin combining these two, formerly disparate interests. That said, while evidence-based ESG investing holds much promise, it remains a relatively new field of study. Challenges and opportunities abound as we seek to create robust data and enhanced analyses to guide the way – in theory and in practice.
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