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An Evidence-Based Approach to Sustainable Investing (First of Two Parts)

Written by Brian Puckett, CFP®, CPA/PFS, Attorney at Law.

If there’s one trait most of us share, it’s a desire to make the world a better place. No wonder there’s so much interest in sustainable investing. Who wouldn’t want to try to earn decent if not stellar returns, while contributing to the greater good?

 

 

But what is the greater good? What is a decent return? How do we make it all happen? Over time, best practices are likely to emerge out of the bubbling brew that is our capital markets, but for those who would rather not wait, it can be hard to identify a clear path forward. As a relatively new and fast-growing field, sustainable investing is crowded with opportunities and challenges, perspectives and priorities, strategies and terminology.

Let’s bring today’s sustainable investing into focus.

Sensible Sustainability

As we grapple with integrating subjective values into objective financial planning, we are inspired by “Doing Good Better” author William MacAskill: “I believe that by combining the heart and the head – by applying data and reason to altruistic acts – we can turn our good intentions into astonishingly good outcomes.”

Let’s be clear: We are NOT here to direct your personal moral compass. We’d prefer to offer objective insights, rooted in our evidence-based investment approach. An evidence-based outlook helps confirm when a theory appears to be robust in reality. It also suggests when a promising plan may not pencil out as hoped for – no matter how well-intended it may be.

Equipped with solid evidence in an often emotionally charged arena, you will be better positioned to make the rational choices and informed decisions that best fit you, your heartfelt values, and your financial goals.

A Tangle of Terminology

While you’re likely to find various terms sharing similar definitions in this crowded field, we’ll refer to the broad subject as “sustainable investing.”

Research shows that different investors embrace sustainable investing for different reasons. Your own priorities govern the type of sustainable investing that should best align with your personal goals:

  • Financial Priorities – Some investors may not be as focused on investing “morally,” but may do so if they expect to earn higher returns from stronger-performing companies.
  • Impact Priorities – Other investors may not care whether sustainable investing brings higher expected returns, as long as they can shun “bad” companies and/or invest in “good” ones.
  • Blended Priorities – Most investors fall somewhere in between: They want to earn solid returns (or not lose money) while investing in principled ways.

How do we measure sustainable investing when the concept itself is subjective? Academics and practitioners typically turn to an organization’s environmental, social and governance (ESG) ratings to try to quantify levels of sustainability.

Precise labels may vary in the various literature, but here are some ways the industry applies ESG ratings into sustainable investment strategies.

  • Active Ownership – Employing “shareholder power” to try to actively improve a company’s ESG performance (engaging senior management, submitting proposals, proxy voting, etc.)
  • Negative Screening – Explicitly excluding firms with low ESG ratings.
  • Positive Screening – Explicitly including firms with high ESG ratings.
  • Inclusion Strategies – Integrating ESG data into existing evidence-based analyses, melding the information into a systematic, total portfolio management strategy

Investors have access to a range of investment solutions that incorporate these and other strategies to varying degrees.

ESG Investing – ESG investors are more likely to emphasize inclusion strategies, which complement an evidence-based investment approach. Evidence-based ESG funds should help investors incorporate sound portfolio construction principles (such as asset allocation, global diversification, and cost control) and minimize less-efficient tactics (such as picking or avoiding specific stocks or sectors based on forecasts or popular appeal). ESG fund managers also may engage in active ownership on behalf of their shareholders.

 

Socially Responsible Investing (SRI) – SRI funds are more likely to use screening strategies that involve making security- or sector-specific judgments or forecasts.

Impact Investing – Impact investors seek not just to invest in a venture, but to become an altruistic partner in it. For example, if you donate to a GoFundMe® campaign seeking to create an eco-friendly alternative to plastic water bottles, you’re an impact investor. On a grander scale, high-net-worth investors may take on private equity or debt structures with an eye toward making an impact with their funding.

 

None of these possibilities are inherently right or wrong. It depends whether you are more value- or values-driven—that is, whether you put financial return first, or consider financial return after the investors’ values have been satisfied. Sustainable investment strategies aren’t mutually exclusive either. For example, you could incorporate ESG investing into the core of your evidence-based portfolio, while participating in impact investing with some of your discretionary income.

Next Up: The Lay of the Sustainable Land

Before sustainable investing existed, philanthropically inclined investors had little choice but to seek their financial returns through traditional investing, while separately expressing their personal values by donating to their charities of choice.

Today, solutions are coming into focus for those who would like to begin combining these formerly disparate interests. While evidence-based ESG investing holds much promise, it remains a relatively new field of study. Challenges and opportunities abound as we seek to create robust data and enhanced analyses to guide the way – in theory and in practice.

In our next piece, we’ll take you on a tour of the evolving landscape.