Once seen as a fringe interest or a worthy diversion from the serious business of investing to maximize profits, sustainable investing has now moved into the mainstream. ESG investing, which prioritizes environmental, social, and governance factors when choosing which stocks and funds to buy into, has seen a huge growth in popularity over the last decade, and especially in the last two years. While some still see this as a fad, others point to a genuine shift in values across society and the investment community, along with the fact that sustainable funds are providing equal returns to, and in some cases are outperforming, their more conventional peers.
Defining sustainable investing
Sustainable investing can be defined by what you choose not to invest in (known as an exclusionary approach) or by what you actively choose to favor in your investment choices (an inclusionary approach). In practice, most investors combine both approaches, avoiding companies that they feel cause environmental or social harm either by their products or by their working practices, while investing in companies that actively put something back into their community, support fair trade and worker’s rights, and have a robust environmental policy.
Sustainability isn’t just about being green, but also encompasses how a company treats its employees and customers, and the impact it has on wider society. It includes things like supply chain transparency, promotion of women and minorities, pricing and corporate responsibility. All these factors can contribute towards making a company more sustainable, because they show acknowledgement that a business exists within society, rather than apart from it. If society and the planet fails, then we all go down with it; no company is sustainable if it isn’t mindful of this fact.
Increasingly, people want to see their personal values reflected in their investment choices, without sacrificing profit. This is particularly true of younger investors, with millennials making sustainability central to their investing strategies. They will make a point of looking for the best environmental stocks that will let them do their bit in the fight against climate change while also making money.
This shift in values has been accelerated by growing awareness of the climate crisis, as well as events of the last couple of years including the coronavirus pandemic and the Black Lives Matter movement. People increasingly want to see corporate transparency and stakeholder accountability, and companies are taking steps to address this. Indeed, ESG funds can include some of the world’s biggest multinationals, including Microsoft, Visa, Apple, and Intel.
According to Morningstar, sustainable funds saw over $51bn in new investments in 2020, more than double the amount in 2019, which was itself a record-breaking year for sustainable investing. In 2020, over a quarter of all newly invested money was in sustainable funds. Although 2020 was not a typical year, with traditionally eco-unfriendly sectors like air travel seeing stocks plunge due to lockdowns, the profitability of sustainable funds is part of a rapidly growing trend.
According to Nordea Equity Research, companies with the highest ESG ratings outperformed those with the lowest ESG ratings by up to 40% between 2012 and 2015. In 2018, the Bank of America Merrill Lynch found that companies produced higher three-year returns when they had a better ESG record than their peers and would become an attractive stock more often – due to being less likely to have serious price drops or go bankrupt.
Investors no longer must make a choice between ethical, sustainable investing and investing for maximum profits, as ESG funds are on average outperforming similar conventional funds and indexes at the higher end of the stock market.
Sustainable investing is seen as a way to manage risk without reducing the potential for profit. A company with a good ESG rating is far less likely to find itself at the center of a scandal such as a pollution spill or inappropriate behavior by an executive, is less likely to find business hampered by strikes and protests and is less vulnerable to new laws and regulations around climate or human rights. Put simply, if a company is committed to doing the right thing anyway, then investors don’t have to worry so much about them being caught out.
Additionally, a good reputation is crucial for market success. It’s not just investors who are acting on their personal values. Customers are much more likely than in previous decades to choose who to buy from based on their ethical and environmental records. Sustainability is part of brand identity and marketing, and a company that is thought to only care about profit will do much less well than one that is thought to be putting something back.
With a wider choice of sustainable funds than ever, there has never been a better time to begin ethical investing. For the investor who wants to do some good in the world and make a profit, it’s a win-win situation.