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A Guide to Sustainable Investing
More and more investors are supporting sustainable companies and green initiatives by moving their money into eco-friendly stocks and banks. However, even if you aren’t familiar with sustainable investing — even if you don’t know much about investing at all — this guide will teach you how to invest and manage your money in a sustainable way while growing your wealth in the process.
Sustainable investing is growing in popularity in no small part because of the public’s increased awareness of our collective impact on the environment. Investors are also beginning to consider the effects of climate change and environmental damage, and what roles they themselves play by holding stock in companies that pollute the environment or release large amounts of carbon dioxide.
Even just a few years ago, sustainable and socially responsible investing were viewed as “activist” approaches to wealth management. Sustainable investors claimed their portfolios were more than just an attempt to make a statement, but most experts still believed such practices wouldn’t provide as favorable a return as a standard portfolio.
Today, that’s changing. At least $26 trillion is now invested in socially responsible and sustainable ways, and socially responsible investing (SRI) assets have been growing at nearly 40% year-over-year since 2016, according to CNBC. There are now more sustainable funds than ever, and experts are beginning to realize that investors can benefit just as much, if not more, from sustainable investing.
Sustainable investing isn’t new, but the fact that more and more investors consider it a viable option for building wealth is a relatively new phenomenon. Still, some people have their doubts. Cathy Curtis, CFP®, a member of CNBC’s Digital Financial Advisor Council, recently pointed out that some clients are still reluctant to look at sustainable investing because of its perceived financial impact: “Eighty percent of the time, the person will say, ‘Yes, I’m interested as long as my return doesn’t get affected by it.’ There’s this persistent myth that you can’t get as good returns with investing for impact.”
This perception is based on the belief that only a few companies can truly be considered “sustainable.” If this were true, it would mean investors would have a much harder time diversifying their portfolios and reducing risk. Thankfully, there is more space in the market than ever for sustainable investors. “Now, there [are enough sustainable] funds where you can build a diversified portfolio,” says Curtis. “There [are] funds represented in every asset class now.”
Some investors pick and choose which sustainable companies they wish to invest in. However, many investors are more interested in sustainable funds. Sustainable money-market funds may be attractive to active investors, while passive investors typically gravitate toward sustainable index funds, mutual funds or exchange-traded funds (ETFs) as a means of generating wealth in the long term.
According to a 2018 report by Morningstar on the sustainable fund landscape in the U.S., sustainable funds performed better than the rest of the overall fund space in 2018. The report found that the returns of 63% of sustainable funds ranked in the top half of their respective categories, up from 54% in 2017.
Introducing Eco-friendly Investing
Generally, sustainable investing refers to environmental, social and governance (ESG) investing. But a sub-set of ESG — eco-friendly investing — is the process of directing investment capital toward companies that seek to combat or minimize the effects of climate change and environmental destruction. ESG investors may also choose to invest in companies which have a track record of corporate responsibility in addition to sustainability. They can also favor companies that have a corporate culture that supports the well-being of their employees and the communities they serve.
The Benefits of Eco-friendly Investing
When more capital is directed toward sustainable companies, it incentivizes those companies, and others, to lean into sustainability initiatives. In turn, companies who wish to remain competitive are forced to analyze their operations and supply chains to identify inefficiencies, waste and the regulatory compliance infractions among their vendors.
For the investor, eco-friendly investing is a way to get peace of mind. If you’re fully invested in sustainable companies, you don’t have to worry that your wealth is working to benefit any companies that are actively destroying the environment or exploiting lax regulations in other countries. Eco-friendly investing also gives you the opportunity to foster innovation at companies that have green initiatives and rely on sustainable energy.
Of course, it’s only recently that experts have taken a second look at eco-friendly investing and realized one of the most important benefits: the opportunity to build a profitable portfolio.
On the company level, there are clear returns for sustainability. For example, according to an article in the Harvard Business Review, companies can experience an average internal rate of return of 27% to 80% on low-carbon investments. For today’s investors, “eco-friendly” and “sustainable” are more than just buzzwords. Almost 90% of fund managers consider sustainable investing “more than just a fad,” according to The Economist. Meanwhile, American sustainable funds have been shown to match or outperform the market, as reported by Morningstar.
Sustainable Investment Criteria
There are three pillars to a sustainable investment, as established by investment research firm MSCI.
Further, each pillar includes multiple associated themes that companies must address if they wish to meet MSCI’s ESG criteria:
- Climate Change
- Natural Resources
- Pollution & Waste
- Environmental Opportunities
Within each theme are key issues, which you can explore in the chart below.
The Environmental pillar includes 4 themes:
Companies that directly address and excel in the themes and issues in this hierarchy can be considered sustainable investments.
How to Invest Sustainably
Just as there are multiple ways to manage a traditional portfolio, there are multiple ways to invest sustainably. You can either take a hands-on approach by investing in sustainable funds and specific companies by yourself, or you can take a hands-off approach by relying on an advisor or robo-advisor.
If you’re new to investing, it may be in your best interest to work with an expert like a financial advisor or at least do some research into best practices before beginning on your own. Generally, investing requires you to allocate some of your money with the expectation of receiving more money later on, known as a “return.” In the financial markets, this typically involves committing your money to a financial asset like a stock or a bond.
Investing is not without risk. It is possible to lose some of, if not all of your investment once its committed. But there are strategies and best practices for lowering risk which can increase your chances of a positive return. Diversification is one such strategy, which we’ll discuss later in this guide.
Keep in mind that “hands-on” doesn’t necessarily mean “active” portfolio management, day trading or ongoing buying and selling. Actively managed funds rarely beat the market. According to research conducted by Standard & Poor’s in 2017, 92.2% of large-cap funds lagged behind a simple S&P 500 index fund over the previous 15 years while mid-cap and small-cap funds lagged by 95.4% and 93.2%, respectively. Day traders are typically professionals or self-employed individuals who manage portfolios for a living. If you’re new to investing, it’s usually in your best interest to avoid day trading, at least for now.
For our purposes, “hands-on” refers to investing without a financial advisor or Certified Financial Planner (CFP) to either advise you or manage your portfolio for you.
If you choose to do it on your own, you should be aware of the many Eco-Smart Index Funds available. These are indices that track the stocks of sustainable companies — specifically those that meet the MSCI ESG Criteria. Put simply, an index is simply a measurement of a specific section of the stock market.
You can use The Sustainable Responsible and Impact Mutual Fund and ETF Chart to get a comprehensive list of sustainable and socially responsible mutual funds and ETFs. In the meantime, here are just a few examples:
- (CRBN) iShares MSCI ACWI Low Carbon Target ETF. This fund invests at least 90% of its assets in the component securities of global companies with lower than average carbon footprints.
- (DSI) iShares MSCI KLD 400 Social ETF. This fund tracks the investment results of the MSCI KLD 400 Social Index, which is composed of U.S. companies that have positive environmental, social and governance characteristics. It invests at least 89% of its assets in the securities of the underlying index.
- (ICLN) iShares Global Green Energy ETF. This is a global renewable energy index fund with a strong dividend. It gives investors exposure to companies around the world that produce energy from solar, wind and other renewable sources.
- (PBW) Invesco WilderHill Clean Energy ETF. This fund is based on the WilderHill Clean Energy Index, investing at least 90% of its assets in stocks of companies that advance clean-energy and conservation efforts.
- (PORTX) Trillium Portfolio 21 Global Equity Fund. This fund invests primarily in companies that are leaders in environmental risk and opportunity management. The fund only includes reasonably priced stocks that have above-average growth potential.
- (QCLN) First Trust NASDAQ Clean Edge Green Energy Index Fund. The objective of this fund is to make investments that correspond with to the price and yield of the NASDAQ® Clean Edge® Green Energy Index (CELS).
- (SMOG) VanEck Vectors Low Carbon Energy ETF. This fund seeks to replicate the price and yield performance of the Ardour Global Alternative Energy Extra-Liquid Index (AGIXL), tracking the overall performance of low-carbon-energy companies and alternative-energy companies.
- (SPYX) SPDR® S&P® 500 Fossil Fuel Reserves Free ETF. This fund eliminates companies from the S&P® 500 that own fossil-fuel reserves.
- (SUSA) iShares MSCI ESG Select ETF. This investment tracks the investment results of the MSCI USA Extended ESG Select Index, which is composed of companies that have positive environmental, social and governance characteristics.
- (TAN) Invesco Solar ETF. This fund is based on the MAC Global Solar Energy Index, which is comprised of companies in the solar-energy industry.
- (TICRX) TIAA-CREF Social Choice Equity Fund. This fund seeks to provide investors with a favorable long-term total return that reflects the investment performance of the overall U.S. stock market, but it gives special consideration to certain ESG criteria.
If you choose to work with an advisor, you have two options. You could go with a traditional financial advisor, such as a certified financial planner (CFP), or you could use a robo-advisor.
When searching for a traditional advisor, pay special attention to advisors who specialize in sustainable investing. While most advisors will be able to guide you toward more sustainable investments, those who specialize in this strategy will have more experience building profitable portfolios. As always, search for advisors with reputable credentials.
A “robo-advisor” is simply a class of financial advisor that provides advice or investment management services online with little to no human interaction. Many robo-advisors rely on computer algorithms and advanced software to build and manage investment portfolios. Whereas traditional portfolio management services typically require high balances, robo-advisors usually have low requirements or no requirement at all.
Some examples include:
- Aspiration.In addition to electronic banking services, Aspiration provides sustainable individual retirement accounts (IRAs) and professionally managed funds that are 100% fossil-fuel-free.
- Earthfolio. This robo-advisor provides exposure to online ESG portfolios.
- Impact Labs. Impact Labs allows you to choose which causes matter to you, and then it algorithmically builds a personalized index of companies optimized for your preferences as well as for return.
- Motif. Motif provides a wide variety of algorithmically driven investment products, including ESG products.
- Newday. Newday lets you build a portfolio in minutes that includes companies which are leaders in environmental and social policies. There are no minimums to get started.
- Sustainfolio. Sustainfolio is a technology-based investment platform that enables clients to integrate sustainability into their portfolios digitally.
If you’re a new investor, you may wish to go with a traditional advisor so they can teach you about investing best practices. However, robo-advisors can be good option if you want to avoid high minimum-investment requirements, avoid advisor fees or invest a small amount of money passively from the comfort of your home.
Diversifying Your Portfolio
In the simplest terms, diversifying your investment portfolio means investing in a variety of financial assets as a means of risk management. This is perhaps the oldest and must reliable form of risk management in the investing community.
If you have many different types of assets, there is less chance that your portfolio will shrink because of a downturn in a specific industry or sector. Instead, you can ride out those downturns without worrying about losing your entire investment, then allow your investments to grow over time.
Naturally, just because you want to invest sustainably, you shouldn’t include any unnecessary risk in your portfolio. Diversifying your portfolio should still be standard practice if you want to earn the highest return for the lowest risk.
The real question is: How much of your portfolio should you invest in sustainable choices? According to experts, there are now enough sustainable choices on the market to build a diversified portfolio. Jon Hale, Ph.D., CFA and Head of Sustainability Research at Morningstar even said, “There’s really no evidence out there that this is an underperforming way to invest.”
If you want to build a sustainable, diversified portfolio, just follow the usual best practices of diversification:
- Invest in more than one type of asset, including bonds, shares and commodities, etc.
- Invest in several different securities within each asset, such as multiple bonds from different issuers.
- Invest in assets with different lifetimes and cycles to reduce the impact of negative market conditions.
- Combine asset classes that have low correlations. In other words, choose a mix of assets which don’t move up or down together to reduce risk.
For example, you could build a portfolio that contains nothing but stocks in alternative energy companies, but your entire portfolio would be subject to market forces in that specific sector. There are plenty of other companies in different sectors, as well as other asset types, that meet the ESG criteria or are considered sustainable.
Divesting from Unsustainable Assets
If you truly want to build a sustainable investment portfolio, you should consider divesting from fossil-fuel stocks and other assets that are tied to polluting organizations. Divesting is simply the act the removing or reducing the amount of wealth (capital) you’ve allocated to those financial assets. While divesting alone won’t topple the fossil-fuel industry, it can have a significant impact.
Our current economy is based on the extraction, consumption and exploitation of natural resources, which is no longer sustainable. Divesting from companies that don’t engage in sustainable practices removes some of their capital (albeit a small amount), incentivizing them to move toward more sustainable practices.
Divesting has become popular as other sustainability programs and initiatives, many of which attempt to change consumer buying habits, have not been shown to make much of an impact.
How to identify “green-washing”
“Green-washing” occurs when an organization falsely conveys to consumers that they favor environmental sustainability when they, in fact, do not. An obvious example might be a trucking company that adds an environment-themed wrapping to their trucks but doesn’t make any sustainable investments in their infrastructure. If you see one of their trucks on the road, you may assume they have an environmental initiative, but it may just be for show.
Another example is when companies brag about a green initiative that is merely the result of what the law requires. Complying with environmental regulations is required by law. Doing so does not constitute “going green.”
The easiest way to avoid companies that “green-wash” is to study investment possibilities before investing. Most ESG assets are marked as such by at least one index, and there is plenty of information online about specific companies and their sustainability practices.
If you are looking to make a “cash investment,” you should consider how you bank and who you bank with. Most banks still operate in a similar fashion to the banks of old. However, more and more banks are beginning to re-examine their environmental impact, both at the branch and at the organizational level.
What’s more, there are now many banks that don’t have a physical presence. Online banking is becoming more popular and fewer people are entering bank branches. Your choice as a sustainable bank customer is whether you want to go with a traditional bank that uses sustainable practices or an online bank that has almost no physical presence.
Sustainable Traditional Banks
In the traditional banking sector, you should look for banks that take a two-pronged approach to sustainability:
- They pursue sustainability through environmental initiatives at the branch level.
- They integrate sustainability into their core business operations.
A traditional bank can’t be considered sustainable simply because it has a recycling program. Instead, it should choose to draw most if not all of its energy from renewable sources, build more energy-efficient branches and do business only with sustainable vendors in their supply chains.
Furthermore, a traditional bank should include sustainability in its core mission. This means incorporating sustainability into the development of their products (including investment products) and in their lending practices. For example, they could lend a certain percentage of business loans to businesses that provide environmental benefits.
Sustainable Online Banks
Because online banks lack a physical presence and rely on fewer paper statements (if any), they are naturally more sustainable than traditional banks. And just like traditional banks, many online banks offer savings products like traditional savings accounts, money-market accounts and CDs.
By going all-digital, you can reduce your own carbon footprint and provide a sustainable bank with more business. You should also consider sustainable online banks that have their own environmental initiatives, such as environmental lending practices and sustainable investment products.