Sustainable investing is a complex topic that has grown from the simple idea of investing only in the stocks that are healthy for the environment, or for society in general.
Naturally, the complexity arises from the difficulty involved in actually defining what ‘sustainable investing’ stands for. By and large, it’s agreed that ESG (environmental, social and governance), SRI (socially responsible investing) and the divisive notion of ‘ethical’ trading are all integral parts of sustainable investing. Depending on your background, attitudes, or upbringing, what makes a sustainable stock could comprise of some notably varied metrics.
Such a hazy summation means that it can be difficult to find advisors for sustainable investing – and even harder to locate texts that match your perceptions over what qualifies as an ESG, SRI or ethical investment opportunity.
With this in mind, let’s take a deeper look into the world of sustainable investing, what it means, where the pros and cons lie, and whether the approach is right for you.
Defining sustainable investing
Sustainable investing is gathering in popularity, and with all emerging movements, the details are a little bit sketchy to begin with. Among varying definitions, it’s generally accepted that ESG investing is the closest single entity to sustainable investing.
(Value of sustainable investment assets in Europe from 2014 to 2018. Image: Statista)
Breaking the anagram down reveals why ESG and sustainable investing are recognised as going hand-in-hand. Environmental equates to stocks related to renewable energy, or the impact a single business holds over the environment. Social relates to how companies deal with a range of issues revolving around fair pay, equality and ethics. Finally, Governance refers to the quality, and goals, that management has for a company.
Private equity lenders often choose to assess various businesses based on their ESG credentials as opposed to other approaches to sustainable investment. They also typically assign particular focus for the management and governance of a company alongside its social and environmental approaches that could impact the business over the long term.
The act of picking sustainable funds is fairly intuitive, due to respective companies being categorised by data providers. But despite this, it can be difficult to find a firm that fully subscribes to the ESG approach throughout.
Some advisers suggest that it’s worth engaging with fund groups to see how companies deal with ESG issues in a bid to see whether they conform to a clear policy or not.
Sustainability is a complex topic and a company’s stance on the environment, society and governance may not always match its actions. To indulge in truly sustainable investing, it’s important to conduct a healthy measure of research regarding the companies that you approach. If a business is failing to meet its ambitions regarding issues like recycling, or equal pay, it makes little sense to regard them as sustainable despite being recognised in some sectors as an ESG investment.
It’s worth noting that sustainable investments don’t operate differently to their non-sustainable counterparts. Sustainable assets can rise in value or fall in value in line with other stocks and shares.
The reason behind the emerging popularity of ESG shares and other environmentally conscious stocks is in no small part down to the growing global urge to act on inequality and climate change. With this in mind, if you’re holding shares in ESG companies, you won’t see your portfolio act much different to that of a non-ESG portfolio, but this isn’t the point of sustainable investing – which is more focused on supporting a healthier ecosystem.
Weighing up the pros and cons of sustainable investing
For investors that are seeking to play their part in combatting social inequality and abuse of the environment, sustainable investing offers up a chance to invest in companies that hold similar values. This means that your portfolio will grow when the companies you support and agree with grow. In many cases, companies that are awarded high ESG ratings are also the ones that are actively at work on creating useful innovations in the world of sustainability – which could make for excellent choices when it comes to building a profitable portfolio.
Fundamentally, investing in sustainable companies helps investors to act against things like climate change, gender inequality and general malpractice by providing a boost for businesses that operate in a much more green manner.
Another positive comes from the fact that sustainable investing is growing in popularity today. With significant increases in social and environmental awareness across the world, shares from ESG companies, in particular, look set to ride this wave of interest and grow exponentially as a result. If this occurs, then investors will benefit from gaining some sizeable profits from green companies along the way.
Of course, investing in ESG shares comes with a few downsides, too. By far the largest drawback comes from the lack of diversity offered by ESG shares. Sadly, most companies that fit the criteria focus exclusively on large-cap stocks which really limit the prospect of diversification among investor portfolios. Thus, investors may find themselves starved of exposure to small-cap, mid-cap and non-US based companies.
Another con is that some ESG mutual funds, as well as ETFs and DIY investors, develop strategies that exclude certain industries entirely – like tobacco and oil. While avoiding these industries is undoubtedly a good thing as far as the environmentally and socially conscious among us would agree, it only serves to enhance the risk of investors placing all their focus on a single industry – such as hydropower or electronic vehicles – which runs the risk of further diversification issues.
For example, a portfolio that’s populated heavily by wind-based energy suppliers is great in terms of adhering to sustainable investments, but investors could find themselves hamstrung if a windfarm is forced to close down, or sanctions lower the global usage of wind power.
Is sustainable investing right for me?
For many investors, it’s relatively easy to answer whether ESG investing is right for you if you’re fully aware of what sustainability really stands for. If you’re somebody who feels strongly about only investing in companies that are recognised to be compliant to certain environmental, social and governance criteria, then logically sustainable investing may be exactly what you’re looking for.
Of course, if you would prefer to use a wider array of portfolio opportunities, then it’s entirely acceptable to look away from the ESG sector of investing. While it may not be as rewarding to buy shares in a company that doesn’t possess a clear set of environmental and social goals, it also doesn’t necessarily mean that you’re showing contempt for sustainability. It’s not a morally bankrupt move to look to secure your financial future outside of the realms of ESG.
If you’re passionate about the things that matter to you, and you find a company that you would otherwise invest in conflicts with your morals, then feel free to take a moment to assess whether you would like to buy shares in them – it’s not a crime to invest in a company that you don’t agree with in order to make a profit for yourself.
It’s also worth remembering that socially responsible investing is a highly subjective matter, and there’s no guarantee that companies recognised as sustainable actually match your beliefs or investing goals.
With this in mind, it’s important to conduct your own research before buying shares. Look for companies that match your ambitions and beliefs and the act of investing in them will be its own reward.