What Is Sustainable Investing?
Sustainable investing considers environmental, social, and governance (ESG) factors alongside traditional financial analysis when making investment decisions. The goal is to generate long-term competitive returns while creating positive societal impact.
Understanding ESG Criteria
Environmental (E)
How a company impacts the environment:
- Carbon emissions and climate impact
- Energy efficiency and renewable energy use
- Waste management and pollution
- Water usage and conservation
- Biodiversity protection
Social (S)
How a company treats people:
- Employee treatment and diversity
- Labor standards in supply chain
- Community relations
- Customer privacy and data security
- Product safety
Governance (G)
How a company is managed:
- Board diversity and independence
- Executive compensation
- Shareholder rights
- Transparency and reporting
- Anti-corruption policies
Types of Sustainable Investing
1. ESG Integration
Incorporating ESG factors into traditional financial analysis. Doesn't exclude any companies but considers ESG alongside returns, risk, and valuation.
Example: A fund might invest in an oil company with strong governance and carbon reduction plans while avoiding one with poor environmental practices.
2. Socially Responsible Investing (SRI)
Excludes companies or industries that conflict with certain values. Uses negative screening to eliminate investments.
Common exclusions:
- Tobacco and alcohol
- Weapons and defense
- Gambling
- Fossil fuels
- Companies with poor labor practices
3. Impact Investing
Investments made with the intention to generate positive, measurable social or environmental impact alongside financial return.
Examples: Clean energy projects, affordable housing developments, microfinance institutions.
4. Thematic Investing
Focusing on specific sustainability themes or trends.
Popular themes: Clean energy, water scarcity, sustainable agriculture, gender equality, healthcare access.
ESG Funds and ETFs
| Fund | Focus | Expense Ratio |
|---|---|---|
| ESGU (iShares ESG Aware USA) | US Large Cap ESG | 0.15% |
| SUSA (iShares MSCI USA ESG Select) | ESG Leaders | 0.25% |
| ESGV (Vanguard ESG US Stock) | Broad US Exclusionary | 0.09% |
| ICLN (iShares Global Clean Energy) | Clean Energy Theme | 0.40% |
| VEGN (US Vegan Climate ETF) | Vegan/Climate Focus | 0.60% |
Does ESG Investing Hurt Returns?
The evidence is mixed but generally encouraging:
Research Findings
- Most studies show ESG investments perform comparably to conventional investments
- Companies with strong ESG may have lower risk (fewer scandals, lawsuits, environmental fines)
- ESG factors can identify well-managed companies likely to outperform long-term
- Some exclusionary approaches may slightly lag during certain periods (e.g., excluding energy during oil booms)
- Thematic funds can be more volatile (concentrated in specific sectors)
Bottom line: ESG investing doesn't require sacrificing returns, but fund selection matters. Look for low-cost, diversified ESG funds rather than narrowly focused thematic options.
How to Build a Sustainable Portfolio
Step 1: Define Your Values
What issues matter most to you? Environmental impact? Labor practices? Governance? Corporate diversity? Your priorities will guide fund selection.
Step 2: Choose Your Approach
- Simple: Replace broad index funds with ESG equivalents (e.g., ESGV instead of VTI)
- Values-based: Use SRI funds that exclude industries you object to
- Impact-focused: Allocate a portion to thematic or impact investments
Step 3: Research ESG Ratings
Multiple organizations rate companies and funds on ESG criteria:
- MSCI ESG Ratings: AAA to CCC scale
- Sustainalytics: Risk-based ratings
- Morningstar Sustainability Rating: Globe system (1-5)
- As You Sow: Fossil Free Funds tool
Step 4: Maintain Diversification
Don't sacrifice diversification for values. Ensure your ESG portfolio spans:
- US and international stocks
- Large, mid, and small companies
- Bonds for stability
- Multiple sectors
Challenges and Criticisms
Things to Consider
- Greenwashing: Some funds marketed as ESG have minimal actual screening
- Inconsistent ratings: Different agencies rate the same company differently
- Trade-offs: Companies can score well on E but poorly on S, or vice versa
- Higher fees: Some ESG funds charge more than standard index funds
- Limited impact: Selling stocks doesn't directly affect company behavior
Making Real Impact
Beyond investment selection, consider:
- Shareholder advocacy: Vote proxies on ESG issues
- Direct engagement: Support firms that engage with companies for change
- Community investing: Credit unions, CDFIs (Community Development Financial Institutions)
- Consumer choices: Often more direct impact than investment choices
Frequently Asked Questions
Is ESG investing just for wealthy or young investors?
No. Low-cost ESG index funds from Vanguard, iShares, and others are accessible to all investors. ESG considerations can benefit investors of any age or wealth level who want to align investments with values.
Can I do ESG investing in my 401(k)?
It depends on your plan's options. Many plans now offer ESG funds. If not, you might request your employer add options, or focus your ESG investing in IRAs where you have more choice.
How do I know if an ESG fund is really sustainable?
Look beyond marketing. Review the fund's actual holdings, screening criteria, and third-party ESG ratings. Tools like As You Sow's Fossil Free Funds can help evaluate fund contents.
Should I divest from fossil fuels?
This is a personal decision based on your values and investment goals. Some argue divestment sends a message; others prefer engagement with companies to push for change. Both approaches can be valid.
