Estimated reading time: 8 minutes
Eco-friendly products, zero-carbon living and sustainable investment are buzzwords we hear often but don’t necessarily know much about.
However, three out of four people don’t understand that they can manage their finances to inspire mindful decisions that don’t negatively impact the environment.
If you want to be a sustainable investor, you must reassess the way you approach risk and how the companies you support make their money.
Table of contents
What Is Sustainable Investment?
Investment is primarily based on risk versus return by selecting companies with products that carry an acceptable exposure, balanced against the anticipated profits.
This concept remains fundamental in any investment, but a sustainable investment also incorporates:
- Evaluating the environmental and social benefits of the investment
- An emphasis on stakeholder diversity and inclusive corporations
- Looking for investments in companies solving global challenges
- Pioneering enterprises that champion new ways of trading
Overall, a sustainable investment will be in stocks, shares, funds or products that embody environmental, social and governance (ESG) values.
It’s tricky to pin down the precise investment decisions you might make from a sustainability perspective because every investor will have different expectations and priorities.
Investments to avoid include anything that has a higher ESG risk or contradicts the investor’s values.
Favourable investments show positive ESG approaches, so capital is invested in ventures that target established environmental or social outcomes.
Examples of sustainable investment choices
Below we’ve listed some of the sustainable investment options available:
- Mutual funds specialising in companies with outstanding environmental practises and leading employment, diversity and accessibility policies.
- Community banks and funding providers supporting communities with low and middle incomes, including those combatting food and fuel poverty.
- Medical institutions, including hospitals, schools and research facilities looking into new techniques or approaches to make medicine more affordable, treatments available in remote or impoverished countries, or tuition available to students without the means to progress to their potential.
- Property funds developing uninhabitable and abandoned properties or retrofitting residential and commercial buildings to the highest energy efficiency standards.
- Pension plans investing in companies reducing greenhouse gas emissions and making climate change a core driver in strategic investment plans.
The list is endless, including everything from investment foundations to crowdfunding campaigns, conventional stocks and shares, AIM products and every asset class in between.
Why Is Sustainable Investment Important?
While sustainability might have traditionally been a ‘nice-to-have’, it’s now a vital criterion for many investors.
These investments are seen as a more stable, long-term investment, with selected products:
- Narrowing gaps in corporate ESG policies to make the workplace more responsible, inclusive and fairer.
- Benefiting from higher corporate governance standards, making the investment lower risk in terms of business rules, processes and practises.
- Delivering environmental benefits by offsetting carbon production, targeting particular ecological issues, or proactively working towards carbon negativity.
Around 80 per cent of households recycle, and 47 per cent avoid buying single-use plastics, but only nine per cent consider their pension savings and how they can leverage that fund for the broader good.
Many pension holders don’t necessarily regard themselves as investors, although 72 per cent are concerned about environmental welfare.
This contrast is perhaps due to a lack of understanding that pension holders can decide which markets or sectors to invest in or specify ESG as criteria for the appropriate fund selections.
COP26 has highlighted these issues, meaning that millions more people are looking into their investments to evaluate whether they have changes to make.
Are Sustainable Investments Less Profitable?
The big challenge for investors is that they inevitably want to choose the assets and products that offer the highest returns.
However, balancing that against selecting investments with high sustainability markers can seem challenging.
The reality is that sustainable investments cover just as broad an area as any other, with options in equity investment, cash, private equity, real estate, venture capital and fixed income products.
There is no indication that sustainable investment results in a less competitive financial return.
Morgan Stanley’s Institute for Sustainable Investing published a report called Sustainable Reality, focusing on this specific issue and analysing 11,000 mutual funds across 14 years to evaluate the trade-off.
The whitepaper concluded that:
- Sustainable funds have a 20 per cent lower market risk than other funds.
- There are no significant or consistent drops in fund returns.
- Investments in sustainable funds may reduce risk with less volatility.
Sustainable investment can be a good option if you are looking for investments with higher returns than the currently meagre cash interest rates and have at least five years before you expect to draw on your returns.
Advantages Of Sustainable Investing
The advantages of sustainable investing are far-reaching.
You can diversify easily and choose from an increasingly large pool of responsible funds, with improved stability and returns from ESG funds.
Choosing a strategic investment approach gives you more control over the types of assets you hold in your portfolio, and you can pick and choose between methods, depending on your overall aims.
There are pitfalls, and you might find that some otherwise attractive investments don’t fit your values and that it takes a bit more time and effort to research a company’s ESG credentials.
Working with a fund manager to research responsibility metrics is often the easiest route to take.
Sustainable Investment At A Glance FAQ
There isn’t a universal list of actions to ensure your investments are responsible, and a lot depends on your values and ethics.
Fund managers and advisers tend to use several tools to vet and recommend different products:
Positive screening, to select companies with a good ESG rating compared to competitors
Negative screening eliminates investments in sectors that are incompatible with sustainability, such as weapons, nuclear energy, fossil fuels and tobacco
Thematic investing, where you choose companies involved in your preferred themes, such as water conservation, women’s rights, or renewable energy
Community investing directs funds into banking or financial businesses serving marginalised, underserved or low-income communities.
A sustainable investment tends to carry a lower risk profile than a non-sustainable one.
That’s because there is reduced exposure to systematic risk and lower volatility since your selected fund will prioritise ESG principles and essentially be a better-managed enterprise.
The cost of capital is typically lower and profitability higher, although it remains wise to diversify a sustainable portfolio across sectors to keep risk at an appropriate level.
Most investment opportunities with a strong ESG profile achieve AA or AAA stock market ratings, although we’d still recommend conducting research or seeking independent advice before making any final decisions.
The increasing emphasis on ethics, sustainability and environmental issues make sustainable investments the fastest-growing trend.
Assets invested in established sustainable funds or products have grown from $639 billion in 1995 to $12 trillion in 2018 in the US alone.
The Financial Times reports that 2013 global investments in sustainable funds reached $2 trillion and had risen to $31 trillion by 2019, with about 25 per cent of all funds now considering sustainability in their decision-making.
Investors focus on sustainability for personal reasons, but there is a financial element too.
Climate change could, if not reversed, erase about $7.75 million from a hypothetical $100 million portfolio every five years.
Rising global temperatures and ecological disruption are threats to humanity, prompting some of the most prominent funds and organisations in the world to commit to net-zero emissions, aligned with The Paris Agreement.
One hundred ninety-six countries have opted into The Paris Agreement, setting ambitious targets to limit global warming and work towards a climate-neutral planet by 2050.
There is a massive amount of underlying economic and social transformation, which is likely to have a tangible impact on all business and finance areas.
Future risks of unsustainable investment choices include loss of shareholder value, higher borrowing costs, regulation compliance issues, and blocked proposals that don’t agree with governmental, regulatory, and lending objectives.
Greenwashing means that something claims to be more sustainable, ecologically beneficial or advantageous to the environment than in reality.
That might include, for example, an airline that offsets its carbon emissions by charging additional duty on long-haul flights and claims to be the greenest in the world.
Most greenwashing accusations are levelled at fossil fuel companies, which use advertising that may detract from the reality of the business model.
Shell is often cited as a greenwashing practitioner, with ClientEarth reporting that the firm claims to use low-carbon products to reduce emissions but has plans to increase the fossil fuel side of the business by 20 per cent.
It would be up to the investor to judge whether they consider that as greenwashing or an acceptable investment.
Related Articles, Guides and Insights
Below is a list of some related articles, guides and insights you may find interesting.
Questions or Comments?
We love to get feedback from our readers. So, after reading this article, if you have any questions or want to make comments, send us a message on this site or our social media.
Don’t forget that you can also request the guides sent directly to your email.