Sustainable investing is an approach for generating financial returns while also having a positive impact on the environment and society as a whole. Sustainable investing looks beyond the financial scope of a company or an asset, and considers various environmental, social and governance (ESG) factors. Let’s delve deeper into sustainable investing, strategies for implementing it and tips for finding the right sustainable investments. A financial advisor can also help you incorporate sustainable investing into your portfolio.
How Sustainable Investing Works
Sustainable investing systematically incorporates ESG factors into investment considerations. It scrutinizes how companies perform as environmental stewards, how they manage relationships with employees and suppliers, as well as their governance practices. This approach helps investors uncover potential risks, rewards and additional perspectives not readily apparent in traditional financial analysis, which prioritizes financial factors.
The concept has exponentially grown over the years. According to the Global Sustainable Investment Alliance, sustainable investing assets hit the $35.3 trillion mark in 2020, a 15% increase from two years earlier. This suggests an increasing appreciation for the importance of ESG factors in investment decisions.
Strategies for Sustainable Investing
There are various sustainable investment strategies, including ESG investing, impact investing, activist investing, exclusionary screening and best-in-class screening.
ESG Investing
Environmental, social, and governance (ESG) investing has emerged as a powerful approach that aligns financial goals with ethical considerations. ESG investing assesses a company’s environmental impact and carbon footprint, as well as its relationships with employees, customers and communities. This approach also scrutinizes a company’s leadership structure, executive compensation and overall transparency.
Impact Investing
Impact investing is not merely a trend; it’s a deliberate strategy by which investors seek to generate measurable positive impacts alongside financial growth. By channeling funds into companies, projects or initiatives that drive social and environmental progress, impact investors are becoming catalysts for change.
One effective approach to impact investing is thematic investing. This strategy involves targeting specific sectors, such as clean energy, education, healthcare or affordable housing. Thematic investing allows investors to focus their resources on areas that resonate with their values and have the potential to make a substantial difference.
Activist Investing
Activist investors actively engage with companies they invest in, advocating for environmental, social, and governance (ESG) reforms. This strategy involves dialogue with boards and management, proxy voting, and even legal actions to influence positive change. By leveraging their influence, activist investors can steer companies toward more sustainable practices, such as reducing carbon emissions, improving labor conditions and enhancing diversity.
Exclusionary Screening
Exclusionary screening is a meticulous process wherein investors deliberately exclude certain industries, companies or sectors from their portfolios based on predefined criteria. This strategy reflects a proactive stance against activities deemed detrimental to society or the planet. Common exclusions span from fossil fuels and tobacco to firearms and human rights violators. The goal is twofold: to make a positive impact on global challenges and to foster long-term portfolio resilience.
By eschewing enterprises that contribute to ecological degradation or social injustices, investors leverage their financial influence to uphold ethical standards.
Best-in-Class Screening
Best-in-class screening involves meticulously evaluating companies within a specific industry or sector based on their sustainability and ESG criteria. This method enables investors to cherry-pick industry leaders in sustainability, encouraging healthy competition and driving positive change across sectors. By allocating resources to corporations committed to reducing their carbon footprint, fostering diversity and ensuring transparent governance, investors can contribute to a more sustainable and equitable future.
To implement this strategy effectively, investors must stay informed about evolving ESG metrics and industry trends. Regularly reassessing the chosen companies ensures they continue to align with sustainability goals and maintain their best-in-class status.
Why Sustainable Investing Is Important
Sustainable investing may contribute to social and environmental shifts. By reallocating capital to sustainable ventures, it may stimulate improvements in business practices, promote economic growth and support environmental conservation.
Additionally, sustainable investing could assist in managing financial risks. Companies failing to handle their ESG risks effectively might suffer reputational setbacks, legal penalties and operational hiccups, thereby affecting their financial performance.
Sustainable investing also resonates with the United Nations’ Sustainable Development Goals (SDGs), providing a blueprint for a greener, more sustainable future. Many sustainable investors use these goals to outline their strategies and trace their impacts.
Return Potential of Sustainable Investing
Sustainable investments have demonstrated competitive performance. In fact, some have outperformed the broader market in recent years. For example, the Morningstar US Sustainability Index outgained the broader equity market by 5.5 percentage points during the five-year between March 31, 2018 and March 31, 2023. The index tracks a wide range of more than 350 U.S. companies with the best ESG ratings and excludes firms with the highest ESG risks.
However, as with any investment strategy, sustainable investing carries risk. Companies may engage in “greenwashing,” wherein they exaggerate their environmental credentials. As a result, investors must conduct thorough due diligence and be mindful of these risks.
Tips for Finding Sustainable Investments
Researching and evaluating sustainable investments can undoubtedly be complex. Assessing a company’s ESG performance can be challenging due to non-uniform ESG reporting. Assessment of ESG performance can include reviewing company policies and reports, benchmarking against industry peers, using data from ESG ratings agencies, as well as direct engagement with the company.
To avoid falling for greenwashing, investors must seek companies with third-party ESG certifications or those rated by credible sources. The Global Initiative for Sustainability Ratings (GISR), the Sustainability Accounting Standards Board (SASB), and the Global Reporting Initiative (GRI) are examples of reputable sources.
Financial advisors can also provide expert advice and guidance, helping investors navigate ESG complexities and spot sustainable investment opportunities.
Bottom Line
Sustainable investing emphasizes the environmental impact of a company or asset, in addition to social and governance considerations. Sustainable investing, which is best suited for investors who prioritize making a positive impact on society, can even outperform a more traditional approach. However, be on the lookout for companies that may overstate or misrepresent their sustainable credentials.
Investing Tips
- A financial advisor can help you select and manage your investments to achieve your financial goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Taxes can play an important role in investment planning. Profits from assets that are sold less than a year after they’re purchased are subject to ordinary income taxes. However, the gains from investments that are sold more than a year after being bought are taxed at the more favorable long-term capital gains rate. SmartAsset’s capital gains calculator can help you estimate your tax liability when selling an investment.
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