Sustainable Investing: What It Is, What It Isn’t, And Why It Matters To You
Sustainable investing was once a relatively fringe investment style, but now it’s a significant part of how our national pension plan is managed. If you haven’t had a client ask about it yet, you probably soon will. Here’s an overview of what you should know.
Although definitions of “sustainable” can vary, most mutual funds and pension plans that pursue sustainable investing analyze companies based on Environmental, Social and Governance criteria, or ESG for short.
Environmental criteria can include issues such as carbon use, pollution and clean water. Virtually every company has some degree of environmental impact, from the obvious heavy industries to the not-so-obvious white collar executives racking up air travel.
Social criteria can touch on things like employee wellness, impact on communities, and presence in conflict regions. Keep in mind that ESG issues are usually considered not only at the head office level, but throughout a company’s global supply chain.
Governance criteria generally relate to how a company is run, from its code of conduct and the diversity of its board of directors, to its quality of risk management and history of run-ins with regulators, lawmakers and tax authorities.
Many investment managers or ESG rating agencies will score companies based on many different criteria within these three categories.
What it is: Investing through a sustainable lens
In the past, sustainable investing was sometimes criticized as a feel-good effort that came at the expense of investment returns. While there is still some debate around this point, there are compelling reasons behind its move into the mainstream.
For one thing, the approach has changed. In the early days, “exclusion” strategies were popular, which meant forbidding entire industries, such as tobacco, alcohol or weapons. Today, most portfolio managers use a more forgiving “integration” strategy, which permits a wider range of businesses as long as they exhibit suitably progressive practices. As a result, performance trade-offs appear to be diminishing.
At the same time, many of the biggest and best companies are becoming more sustainable by choice. Sustainable investing is taking on a double meaning, as business leaders increasingly realize that strong ESG scores not only help sustain our shared environment and social fabric, but also their long-term profitability.
What it isn’t: The right choice for every situation
If a client expresses an interest in sustainable investing, you might want to include some options in your analysis and consider whether they are appropriate to recommend.
Having said that, there will be cases where a GIC is simply the best match for a client’s risk/reward profile, or where an aggressive growth fund will generate the long-term growth they need, or where you want exposure to a certain investment style or asset class that just doesn’t offer a compelling sustainable investing option.
As always, your job is to understand a client’s overall goals and preferences, and render suitable advice. Sustainable investing can be part of your recommendation, but it’s likely not a core investment objective in and of itself.
Why it matters: Demonstrating relevance and value
From a business development point of view, younger audiences seem to have heightened awareness and interest in sustainable investing. If this is your primary market, or if you have clients with Millennial or Gen Z kids, this is a topic that can lead to relevant conversations.
Another interesting aspect of sustainable investing is that it generally requires active portfolio management and diligent fund selection. In an era with more self-directed investing options than ever, you have an opportunity to replace some of this DIY investing with professionally-managed ESG.
Although there are global initiatives underway that could lead to more standardized approaches to sustainable investing, ESG scoring methods are largely subjective and each organization has its own take. Do not underestimate the value of your due diligence on this topic.
In summary, sustainable investing is a growing and evolving field. As an advisor, it certainly makes sense to be conversant and, depending on your client base and business development goals, you may even decide to make it a key part of your practice.