What is Sustainable Investing and Is It for You?
Sustainable Investing Explained: The Basics and Is It for You?
Many of those who plan on investing may have heard of sustainable investing before. You may have a vague idea of what it is but are yet to know the specific details of this method. This article will remarkably aid in clearing doubts regarding sustainable investing. Go through the points indicated to verify if this method of investment is for you.
Federal Regulator Proposes a New Investment Rule
Federal regulator brought this rule up months ago, last June. According to this rule, workplace retirement plans will be restricted from investments with ESG considerations. ESG stands for environmental, social, and governance—this rule is popularly known as socially responsible or ESG investing. Moreover, this approach highlights the sustainability of the business practices of companies.
However, many find this proposal unusual. Because of that, the rule gained numerous opponents consisting of the largest investment managers in the world. Giants such as BlackRock, Fidelity, State Street Global Advisors, and Vanguard denounced this proposal. According to them, this new rule will increase the risk for workplace plans offering ESG.
Furthermore, the Investment Company Institute, American Bankers Association, and the U.S. Chamber of Commerce also spoke about this. According to them, the rule may raise costs and limit options for investment—thereby increasing the risk for lawsuits.
The Proposed Rule is Outdated
Based on numerous companies, this rule might have been relevant 20 years ago. In the past, socially responsible investing consisted of a handful of funds. These funds excluded entire industries for religious, political, or social reasons. Additionally, they sometimes sacrificed returns during the process.
As the years went by, socially responsible investing has gradually evolved into sustainable investing. Sustainable investing aims to refrain from making value judgments. Instead, it looks for companies that make a beneficial quantifiable impact and avoids those who pose harmful risks.
Sustainable Investing 101
Sustainable investing is also known as values-based investing, ethical investing, socially responsible investing, and impact investing. Simply put, sustainable investing means investing in a way that is beneficial to society or the environment. This strategy may be as simple as avoiding industries and companies whose products go against your morals and values. Additionally, you may also invest in ways that you think are crucial to achieving specific goals.
History of Sustainable Investing
As mentioned, sustainable investing began as SRI or socially responsible investing. This practice in the country dates back almost a century. Here are examples of known practitioners of SRI.
- Religious Society of Friends who refused to participate in the 1700s slave trade
- Investors for the 1960s civil rights
- Investors against the 1980 apartheid policies
Before, investors were hesitant about the idea of SRI. They had the notion that this practice tends to reduce returns. However, this conspiracy has been disproven through research. For example, average sustainable funds outperformed both traditional peers and indexes in 2020. This data is according to the 2021 Sustainable Funds U.S. Landscape Report of Morningstar.
How Does Sustainable Investing Work?
There are two fundamental types of sustainable investing. The first is socially responsible investing (SRI), which follows an exclusionary method. On the other hand, environmental, social, and governance (ESG) investing is more broad-based. Investors sometimes use these two terms interchangeably, but they have their unique characteristics.
Socially Responsible Investing (SRI)
With socially responsible investing, investors screen stocks or funds based on their criteria. From there, they make their investment decisions. Some abstain from investing in companies that go against their values.
An example of SRI is choosing not to invest in sin stocks. Sin stocks comprise those issued by gambling, alcohol, and tobacco corporations. Moreover, SRI investors might also stay away from companies that manufacture weapons.
Environmental, Social, and Governance Investing
On the other hand, environmental, social, and governance investing takes on a more proactive approach. Investors first evaluate the due diligence factors in companies that they are considering. For example, oil and gas companies may be a responsible investment if they give back to the community. They must also do their part in reducing carbon emissions.
To guide their ESG investment decisions, investors rely on measurable ESG factors. Experts and analysts are responsible for studying this subject matter and laying out potential factors. Here are some examples of them.
- Environmental factors. Clean technology, use and conservation of water, carbon emissions
- Social factors. Anti-bias and diversity issues, community development, safety and benefits of employees in the workplace
- Governance factors. Anti-corruption policies, diversity in the board, political contributions of the corporation
Benefits of Sustainable Investing
Based on its description, sustainable investing is good for society and the environment. Unbeknownst to a lot of investors, sustainable investing also holds great potential for financial profit. Here are the advantages of investing in companies with high ESG ratings based on surveys by MSCI, an American index provider.
A High ESG Rating Means Lower Risk Exposure
Generally, companies with a high ESG rating have uptight methods for risk monitoring. This strictness is a perk for the investor since this significantly reduces risk exposure.
A High Sustainability Rating Means Higher Dividends and Greater Profitability
Based on recurring trends, companies with sustainable strategies tend to be more future-oriented. With that, they attract a talented and robust workforce. This attraction strengthens their innovation culture within the company.
A High ESG Rating Means Better Company Performance
Companies with high long-term ESG ratings exhibit better performance compared to companies with deteriorating ESG ratings.
Final Words
Sustainable investing holds the potential for multiple benefits. If you are firm on your views and principles, this method might be for you. If you want to try sustainable investing, keep these points in mind when screening the companies you want to check out.
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