Sustainable investing seeks to align investment decisions with the investor’s social and environmental values while still generating long-term returns. Earning a profit is typically one of the top priorities for investors, but with sustainable investing, profit isn’t the only goal. Creating an impact is equally if not more important.
Learn what sustainable investing is and how it works, as well as some easy strategies if you want to invest in a way that doesn’t conflict with your conscience.
Definition and Examples of Sustainable Investing
Sustainable investing is a strategy where you invest in a way that benefits the environment or society. It can be as simple as avoiding companies or industries whose products conflict with your objectives, morals, and values. You can also invest in ways that you believe will advance certain goals. You may hear sustainable investing referred to as ethical investing, impact investing, socially responsible investing, and values-based investing.
- Alternate names: Ethical investing, impact investing, socially responsible investing, values-based investing
By the end of 2019, professionally managed assets using sustainable strategies grew to $17.1 trillion, a 42% increase compared to two years prior, according to the U.S. SIF Foundation. The organization also estimated that $1 out of every $3 under professional management is invested under sustainable practices.
But the history of socially responsible investing, or SRI, in the United States dates back hundreds of years. Quakers affiliated with the Religious Society of Friends are sometimes credited as early practitioners because they refused to participate in the slave trade in the 1700s. More recently, socially responsible investors supported projects that advanced civil rights in the 1960s and divested from South African companies in protest of apartheid policies in the 1980s.
In the past, some investors avoided sustainable investing, fearing it would reduce returns. But a growing body of research suggests the opposite.
In 2020, sustainable funds, on average, outperformed both their traditional peers and indexes, according to Morningstar’s 2021 Sustainable Funds U.S. Landscape Report. For the trailing three-year period, 75% of sustainable funds ranked in the top half of their Morningstar category. Fifty-two percent of sustainable equity funds ranked in the top quartile.
How Does Sustainable Investing Work?
Though sometimes used interchangeably, there are two main types of sustainable investing: socially responsible investing (SRI), which follows an exclusionary approach, and the more broad-based path of environmental, social, and governance (ESG) investing.
With SRI, investors may make investment decisions by first screening funds or stocks based on certain criteria.
Many investors simply refuse to invest in companies that conflict with their values. They may avoid investing in “sin stocks,” or those issued by corporations in the tobacco, alcohol, and gambling industries, or companies that make weapons.
Some mutual funds and exchange-traded funds (ETFs) appeal to sustainable investors by avoiding certain industries. For example, as of Dec. 31, 2020, the SPDR S&P 500 Fossil Fuel Reserves Free ETF (SPYX) was invested in 491 of the 500 companies in the S&P 500 index, excluding those that own fossil fuel reserves.
ESG investing, on the other hand, often takes a broader and more proactive approach by evaluating due diligence factors in companies. For example, an oil and gas company could be considered a responsible investment if it is committed to reducing emissions and giving back to its communities.
ESG investment decisions tend to rely on measurable ESG factors, as laid out by analysts. For example:
- Environmental: Carbon emissions, water use and conservation, clean technology
- Social: Workplace safety and benefits, community development, diversity and anti-bias issues
- Governance: Board diversity, corporate political contributions, anti-corruption policies
These factors can be used to evaluate individual stocks, but many mutual funds and ETFs focus exclusively on high-scoring companies. One example is Vanguard’s Global ESG Select Stock Fund Investor Shares (VEIGX). According to Vanguard, this fund is for investors seeking “exposure to companies with leading ESG practices,” but it may not be ideal for those looking to exclude certain sectors or companies from their investments.
As of Dec. 31, 2020, VEIGX had 38 holdings, the largest of which was Microsoft. Microsoft has publicly stated its corporate social responsibility goals and commitments to sustainability.
Then there are funds that focus on specific social and environmental goals. For example, VanEck Vectors Green Bond ETF (GRNB) invests in green bonds, which are bonds whose proceeds go toward environmentally friendly projects. You can also find funds that invest in furthering causes such as gender equality, like the SPDR SSGA Gender Diversity Index ETF (SHE), or clean water, such as the Fidelity Water Sustainability Fund (FLOWX).
What Sustainable Investing Means for Individual Investors
Investors have a number of different investment options to choose from that can align with their values and philosophies. With sustainable investing gaining more traction, companies are disclosing more information to investors so that they can evaluate investment opportunities with it in mind. For example, public companies now often use their earnings calls to effectively communicate their ESG strategies.
Keep in mind that when a corporation announces a commitment to human rights or clean energy, that doesn’t necessarily mean it will follow through.
An investment company’s ESG criteria can be one tool investors use to identify how corporations measure up. Investment companies often assign ESG ratings to mutual funds and ETFs, but the presence of a score doesn’t mean the fund is designed for ESG investing.
If you want to invest in sustainable funds, look specifically for ESG funds or those targeted toward your goal. Using a stock, mutual fund, or ETF screener can also help you search for investments that meet whatever ethical criteria you choose.
Research has also found that ESG fund expense ratios—the percentage of the investment that goes toward fees—are typically similar to what you’d pay for a traditional mutual fund in the same category. That means investors may be able to get started in sustainable investing without paying more to do so.
- Sustainable investing is a strategy for investors seeking to earn financial returns in a way that’s in sync with their values.
- By the end of 2019, about $1 of every $3 under professional management in the United States was invested according to sustainable practices.
- Some investors avoid investments in stocks or industries that don’t align with their objectives.
- ESG ratings can help investors choose individual stocks and funds to invest in that align with their goals and values.