With all the global tragedies we’re experiencing as a result of climate change – wildfires in Australia and California, extreme weather across every continent – there has never been a better time to consider the consequences of our environmental footprint on this planet.
On an individual basis, many people are experimenting with plant-based diets, minimizing consumption and being more conscious of where they put their money – and that includes ethical investing.
This is evidenced by the substantial growth in SRI (socially responsible investing), ESG (environmental, social, and governance) investing, and impact investing.
These funds account for over $12 trillion in assets under management, according to a 2018 survey by the U.S. Forum for Sustainable and Responsible Investment. This trend will continue to grow as we see a shift in consumer awareness and behavior.
While these terms are often used interchangeably, there are fundamental differences in how portfolio managers select the companies that go into their funds.
Socially responsible investing has been around since the 1970s and has been touted as too stringent – it was essentially a black-and-white approach that negatively screened companies based on specific ethical guidelines.
For example, it looked down upon companies involved in firearms, tobacco, adult entertainment, etc.
Essentially, SRI is based on principles and balancing economic profit.
ESG has provided investors with a broader selection of investments for their portfolios. ESG funds are driven by how environmental, social, and governance factors affect the financial performance of a company.
Financial performance is the primary objective, but these factors are integrated into the fundamental investment process, and fund managers use a framework to quantify the impact these factors have on the long-term profits of the companies they select.
For example, a portfolio manager might look at a company and assess their business model – do they have sustainable competitive advantages that allow them to achieve long-term profits? If so, how are they addressing environmental, social, and governance?
According to Bloomberg, Google (Alphabet) is the world’s biggest corporate buyer of green energy in 2019.
You’ll find when you dig into the top holdings of ESG funds, they will be heavily weighted toward technology companies.
One can argue, according to the chart above, that while Walmart adapts green energy policies, they don’t look so good when it comes to social standards. Walmart has faced accusations of providing poor working conditions and low wages for their employees.
This means Walmart may rank lower on the ESG scale, or be completely excluded from some funds.
This is one of the challenges when it comes to ESG investing : The standards may be loose for ESG Index funds, but tighter for ESG mutual funds as the portfolio managers have a say over which companies are screened.
Nowadays we’ll see a blend of SRI and ESG standards.
Impact investing focuses on addressing a specific social or environmental issue whether the company will be financially successful or not. Economic profit is not a priority. However, this doesn’t mean impact and profit are mutually exclusive. The purpose of impact investing is to ensure a positive social or environmental result with the capital that has been deployed.
While we can sit here all day and debate ethics and company morality, when it comes to building a sustainable investment portfolio, it ultimately comes down to what you value, and what you’re willing to accept.