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Sustainable investing means different things to different people. For some it is about avoiding certain activities or industries. Others see it as a more proactive approach—making a positive difference. Not just “do no evil” but being a force for change.
A helpful way to think about the range of approaches is as a spectrum that runs from conventional investing all the way through to philanthropy.
At one end of the spectrum, conventional investing is out of the scope of sustainable investing because it mostly doesn’t consider environmental, social and governance (ESG) issues. At the other end of the spectrum is philanthropy. Philanthropy isn’t considered sustainable investing because it is less about investing and more about giving.
In between conventional investing and philanthropy are five approaches you can consider as a sustainable investor.
When investment professionals say that sustainability is a core part of their investment process (as many do these days), what they are really saying is that their analysis includes some assessment of the financial risks of ESG factors to the companies they are considering investing in.
For many Canadian investors who are looking to take a sustainable investing approach, this might feel too close to conventional investing to really meet their needs. What’s at stake here is how aware a company is of the relevant risks to its business, and how well it is managing them. All good stuff. But a company scoring highly in this regard may still be doing things that we don’t feel are “responsible” or “ethical.”
This is traditional “ethical” investing. It is about avoiding or excluding companies doing things that are considered “questionable”—things like weapons manufacturing and trading, alcohol and tobacco sales or fossil fuel extraction. Where you draw the line on this list is a matter of your personal values.
Negative screening strategies can also have a risk management dimension. For example, changing values or regulatory shifts may mean that the oil and gas business is in long-term decline. Its cost of capital may rise over time. Many of the reserves booked by energy companies may never be exploited. These are all real financial risks that investors can potentially avoid by using an exclusionary approach. But ultimately, exclusion is most often a moral question.
This is the flip side of exclusion. Best-in-class screening involves looking for companies that score well on ESG factors. Again, this can have either a financial or an ethical focus. And increasingly, the evidence is mounting that the two concerns are inseparable.
Analysis by Fidelity International found that companies that score highly on ESG factors outperformed in both down and up markets in 2020. A good ESG score is a kind of proxy for quality. Companies that understand the forces shaping the world around them and respond appropriately are, by definition, better companies. And investors are increasingly rewarding them with a higher valuation and a lower cost of capital.
This category sits right in the middle of the sustainable investing spectrum. Accordingly, a mutual fund or an exchange-traded fund (ETF) in this group might have more of a profit focus or be more concerned with ethical values. You will need to look under the hood, read the fund’s objectives and see if the manager’s interests are aligned with your own.
Investing in a sustainability theme does not necessarily mean you are committed to changing the world for the better. It might just mean that you have seen which way the wind is blowing (literally, in the case of renewable energy) and recognized the long-term investment opportunity a sector or theme represents.
For investors who see their money as a mechanism for creating a better world, this final category will likely be the most interesting. As its name suggests, it includes funds that invest in companies focused on social and environmental improvements. They might, for example, include investments in social housing or in businesses trying to create jobs for ex-offenders.
And there is a spectrum within the spectrum here, because funds may have differing demands of their investments with regard to the financial returns they deliver alongside their ethical impact. Again, it’s your decision how far toward philanthropy you want your investing to veer.
This is obviously a simplified view of a pretty complex picture, and not all funds will fit neatly within one category. An impact fund may apply negative screening as well, for example. We hope, however, that this article provides a starting point for your exploration of the world of sustainable investing.