Sustainable investing is one of those terms that looking up in the dictionary only leads to needing to look up even more terms in the dictionary. What should be a straightforward process is actually the fork in a trail that branches in a half dozen directions. Because there is no one way to invest sustainably; there are four.
“Sustainable investing is an umbrella term encompassing SRI, ESG, thematic investing if based on environmental or social values, and impact investing,” says Sonya Dreizler, a consultant to financial services firms about impact investing and ESG at Solutions with Sonya. “All screen for risk and create competitive returns but with different approaches.”
To determine the right sustainable investing approach for you, think about what you’re trying to accomplish with your investments, says Anita Baldwin, head of research and sustainable investing for Hartford Funds. She would also add thematic investing to the group gathered under the sustainable umbrella.
Do you want to divest the bad by selling certain stocks or industries from your portfolio? (SRI) Or are you more interested in buycotting by investing in companies doing good? (Impact investing)
Before You Start Sustainable Investing
Whichever form of sustainable investing you use, “it’s important to look past the name of the fund or portfolio to understand the underlying holdings as well as the intentions of the portfolio manager,” Dreizler says.
The best way to do this is by looking at the asset manager’s history, Baldwin says. There’s a difference between just calling yourself sustainable and actually putting resources toward it and the truth is in the track record.
She recommends using asset managers who have a team of analysts dedicated to sustainable investing research and practices.
And if you care about not giving up returns while investing sustainably, look for a fund that’s benchmarked to a broad-based index, Baldwin says. This shows the fund manager is attempting to provide market-like or possibly better-than-market returns.
“Sustainable investing benchmarks, like an environmental index, can be useful as a measure of comparison, but they can’t speak to if a fund manager has an eye on the market at large as well,” she says.
Keeping these considerations in mind, you can begin to sort through the universe of sustainable investing strategies to find the right approach for your values and your portfolio.
Socially Responsible Investing (SRI)
The catchword for SRI investing is values, Dreizler says. “SRI typically means values based investing,” where the values can be those of the investor or the SRI fund’s philosophy.
“SRI uses targeted investing, divesting (screening out) of companies and industries, proxy voting and shareholder engagement (conversations with company management) to align investments with stated values,” she says.
A common approach to SRI investing is to exclude “bad actors,” companies or industries that don’t align with your values. “The most common things that fall into that kind of exclusionary bucket are fossil fuels, firearms, tobacco (and) alcohol,” Baldwin says.
Sites like Morningstar or AsYouSow.org provide tools you can use to find funds that exclude your chosen ill.
The danger with the exclusionary approach is that the more you exclude, the narrower your investing universe becomes. This could make it hard to get benchmark-like returns, which may be fine if you have a strong stance on your values, but is something to be cognizant of, Baldwin says.
“ESG investing considers environmental, social, and governance data in addition to traditional financial metrics in the investment decision making process,” she says. How portfolio managers use that data will vary.
“It could be that the investment team is considering these factors but not necessarily (letting them) drive investment decisions,” Baldwin says. For instance, they acknowledge a given company may be poorly rated on an ESG scale, but decide it still serves a purpose in the portfolio.
Then there’s true ESG integration with “systematic and explicit inclusion of these factors” into fund analyses, Baldwin says. In this case ESG factors will play an integral part in buy and sell decisions.
In either case, it’s important to understand what your fund is doing and what level of influence ESG factors have over investment decisions. Baldwin says to look to the fund prospectus or fund manager website for a detailed explanation of the investment process.
If you’re an individual stock investor, ESG investing gets a bit more complicated, especially for U.S. investors as ESG disclosures are less mandatory in the U.S. than other parts of the world, Baldwin says.
In a themed product, the selection of investments is tied to one or more themes, Baldwin says. For instance, a climate change-themed fund may invest in companies trying to solve climate issues, she says. “You’ll see a lot of wind turbines, electric vehicles and those types of companies in funds like this.”
Climate change funds could also have companies that may not immediately scream “climate change” but are actually having an impact. “You’ll see companies like Amazon (ticker: AMZN) and Facebook (FB) in environmentally themed portfolios because of the steps they take toward green buildings and the vehicles delivering their services are electric,” Baldwin says.
Your themed fund can serve a dual purpose in your portfolio: You could potentially have an environmentally themed fund that provides your small-cap exposure because of the companies it invests in, Baldwins says.
She says the best place to find themed investments is probably through a Google (GOOG, GOOGL) search or an asset manager who specializes in themed investing, which you can also locate through trusty Google.
The keyword with impact investing is intention, Dreizler says. It’s about investing with the express intention of furthering positive change.
“Impact investing looks for companies making a positive difference for people or planet as part of the company’s mission and way of doing business,” she says.
Impact investing strategies target big world problems from ending world hunger to climate change.
As the newest form of sustainable investing, there aren’t as many impact investing strategies as with others under this umbrella, Baldwin says.
Impact investing has also historically been available only to accredited (a.k.a. wealthy) investors, but that’s changing.
“Some of the most popular sites for individual impact investing have opened up to both accredited and non-accredited investors, meaning you no longer have to be a high-net-worth investor to align your dollars with your values,” says Catherine Berman, CEO of CNote.
“On the public equities side, sites like Nia Global Solutions and NewDay provide access to socially responsible and targeted strategies,” she says. “On the fixed income side, Calvert and my company, CNote, allow individuals to invest with as little as $1.”
If you’re interested in impact investing, Berman says to “know your options and be honest with yourself about your risk tolerance. If you are excited about investing with your values but are not in a position to lose that money, discuss various options that offer federal insurance, protection or guarantees with your financial advisor.”
She points to the Self-Help CD, Calvert Impact Capital Note and the CNote Flagship product as place to start impact investing without needing to make a significant commitment.
But be warned: Once you start, it may be hard to stop.
“Impact investing is addictive,” Berman says. “Once you realize this is another way to vote for what you believe in, you’ll likely want to do it again and again.”