Whether you’re a frequent investor, a climate change advocate, or a little bit of both, you may have heard the term “sustainable investing” floating around. Also referred to as Environmental, Social, and Governance (ESG) investing, this booming industry is certainly one to follow and get involved in, if you’re someone who wants their investments to contribute to the social good with the potential to earn better returns — sounds pretty good, right?
As with any form of investing, we must go in armed with all the information, feeling prepared to make decisions that align with our values and will benefit us long-term. We turned to Brendan McCarthy, an ESG Research Analyst for Calvert Research and Management, for an education about dipping our toes into the ESG waters. So, for those who want to learn more about sustainable investing and how they can get started, ride along with Loop as we get all the intel.
So, what even is sustainable, or ESG, investing? Put simply, this is a form of investing that takes into account a company’s mission, ethics, and impact as it relates not just to social responsibility but financial returns as well. As McCarthy explains, “The traditional way of analyzing a stock is by looking at metrics like revenue, earnings growth and valuation. But what those metrics may not fully take into account are environmental, social and governance factors that can mitigate risks and create long term opportunities.” By engaging in sustainable investing, we are considering not just the ways in which companies will use our money for good, but how this can lead to greater returns and long-term success.
Great question. In the past, the ESG industry was referred to as SRI, or socially responsible investing. The difference between SRI and ESG was that with socially responsible investing, there was a trade off. You could know that your investments were being used for good, but the returns on those funds were often lower compared to competitors who weren’t partaking in socially responsible investing.
How it worked, as McCarthy outlines, was that, “Funds managers would say, ‘Okay, we'll own all of the companies in an index, but we're not going to hold any tobacco, guns, or fossil fuels. It was a very blunt approach.” Now, with ESG, we have managed to create a system that doesn’t just take societal good into account, but also can outperform benchmarks and generate higher returns. “That was the old school way, but now we’re using ESG factors to uncover value, in taking advantage of opportunities and in mitigating risks.” So, that’s why you should care. Because sustainable investing is a smart way to care about the world around you while cleverly assessing risk in a new way that will benefit you and your savings long-term.
Still not sure? Let’s look at an example from McCarthy. Human capital, which would fall under the social pillar of ESG, is one way an ESG investor may assess a company. While traditional investors likely wouldn’t look at human capital — meaning a company’s workforce and how they value their employees — an ESG investor would take a different approach.
McCarthy explains, “ESG investors will look at what those companies are doing to attract those employees, to retain them, to increase diversity among the employees.” The key is that this isn’t just important because it provides more opportunities to those who are frequently shut out off the job market, but it also determines a company’s success and worth. “If a company is working hard to expand its hiring and promotion pools to include diverse candidates, they can access a much broader talent pool, and secure more skilled employees, than competitors,” McCarthy says. More diversity and inclusion efforts will lead to better talent, which is a great reason to invest in a company.
We can get another clear example when turning to the environmental pillar of ESG. As our society modernizes and more companies are aiming to be net zero — or reach carbon neutrality — climate change regulations are also being put in place. “That's something that traditional investors aren't looking at,” McCarthy explains, “but ESG investors are looking at that and saying, ‘Alright, here's two companies that compete, and one of them has much higher emissions.’ As climate change regulations come into place, the higher emitting companies are going to face huge costs and penalties, so ESG investors are viewing those emissions as a risk.”
Therefore, companies who are carbon neutral are not just helping save our planet, but can also be less risky investments than their non-carbon neutral competitors.
Step one: Research firms and consider engaging a financial advisor who can help you to navigate ESG investment opportunities that are best suited for you. Make Google your best friend and start getting a feel for what firms are out there, firms that will have their own ESG funds for you to invest in. When doing so, McCarthy encourages us to dive below the surface and see not just if a firm has an ESG label, but if they are a leader in the space and are releasing thoughtful research. “Are they putting out white papers, blog posts, etc, on cutting edge ESG research?” McCarthy asks. “You'll find that the ones that are putting out that research are the ones who are dedicating a lot of energy to do this the best, rather than just greenwashing, which is a term for firms that just slap an ESG label on a fund and make a few changes.” Calvert, McCarthy’s home base, is one example of a firm who is a global leader in ESG research.
Step two: Figure out what is important to you. After you have familiarized yourself with trusted firms, it’s time to pick a fund, or funds, you would like to invest in. “If you have a general interest in ESG and how it can generate returns for shareholders and other stakeholders, one option could be ESG index funds,” McCarthy says.
However, if you have a more specific mission that you are passionate about, you may lean towards thematic funds, which focus on one issue. “If water is important to you, or if you view water usage as a big risk and/or opportunity going forward, then look for funds specifically that focus on water,” McCarthy explains. Among the options in this area is the Calvert Global Water Fund, which specifically selects companies that are global leaders in water usage. Thematic funds allow investors to pursue market exposure to specific interests if you feel strongly about a cause or specific ideas.
Step 3: Go get ‘em. Sustainable investing may feel a little foreign and confusing at first, but this industry is undoubtedly on the rise and one to pay attention to. As Morningstar reported, ESG funds more than doubled in the year 2020, they show no signs of slowing. With these key tips in one hand and your core values in another, you’re prepared to dive into the world of sustainable investing.