If there’s one trait most of us share, we want to make the world a better place. No wonder I’ve been hearing “No Dumb Questions” on sustainable investing. Or it’s also known as “ethical,” “socially responsible,” “ESG,” or “impact” investing.

Call it what you will, there’s a growing interest in earning decent investment returns, AND contributing to – or at least not harming – the greater good while you’re at it.

To that, I say, hooray! But there’s also the fiduciary in me. One of my social responsibilities is to advise you, on what I believe is in your best financial interests, regardless of what’s currently hot, or not.

So, today, we’ll embark on a two-part tour of sustainable investing. To sustain your access to this and future “No Dumb Questions,” don’t forget to subscribe to my YouTube channel, or connect with me on LinkedIn.

As a fast-growing field, sustainable investing is bursting at the seams with opportunities as well as challenges. In fact, it’s growing so fast, we’re not even sure what to call it. Is it sustainable or ESG? Socially responsible or impact investing?  Different people embrace different types of ethics-based investing for different reasons. Your own priorities govern the moves that make the most sense for you.

Some investors may give their financial goals top priority. Others may decide the impact of their investments matters more. Many investors who want to invest more sustainably fall somewhere in between. You’d like to earn a decent return, while still investing in a relatively principled way.

But guess what? Principles are hard to measure! One person’s virtue may be another person’s vice. Plus, it can be tricky to sort through different companies’ reports and come up with apples-to-apples comparisons on what is often very subjective stuff. Sustainable investing is new enough that rigid standards for how to quantify “good” or “bad” behavior are still very much a work in progress.

To find answers, we typically turn to an organization’s Environmental, Social and Governance (ESG) ratings to try quantifying levels of sustainability. As I’ll touch on in my next “No Dumb Questions” post, these ratings are NOT infallible. But they at least offer a starting point. As my colleague Peter Guay describes in his own video on the subject:

Environmental factors consider a companies’ impact on air quality, land, water and human health. Social factors consider companies’ human rights records and support for the communities in which they operate … Governance factors consider executive compensation practices, board diversity and corporate risk management.”

With ESG ratings in hand, there are various ways fund managers go about using them.

  1. Screening: Some use negative screens to exclude any “bad” firms whose ratings are too low. A fund can also use positive screens to only include “good” firms whose ESG ratings are high enough.
  2. Direct Intervention: A fund company may also use “shareholder power” to try to engage directly with a holding’s ESG performance. For example, they may consult with senior management, submit proposals or vote on shareholder proxies, seeking to “improve” a company’s behaviour.
  3. Inclusion: A manager can pursue an inclusion strategy by starting with a basket of holdings that are consistent with the fund’s overall goals, and then including ESG ratings as part of the equation.

Those are possible strategies for investing more sustainably. Investors also have access to a range of solutions that incorporate them.

  1. A passively managed ESG fund is most likely to combine inclusion strategies, with shareholder strategies, such as voting shareholder proxies, etc.
  2. Socially Responsible Investing or SRI funds are more likely to use stand-alone screening strategies. They also may involve stock-picking or market-timing tactics. In other words, besides incorporating ESG ratings, many SRI funds are actively managed. As I’ve covered in past videos, active tactics tend to add unnecessary cost and drag on expected returns. At least with respect to your financial outcomes, that’s generally a bad idea in any
  3. Impact investing is best suited for those who don’t just want to invest in a venture. They want to partner with it. For example, if you donate to a GoFundMe® campaign to create eco-friendly water bottles, that’s impact investing. So is higher-end private equity or loans that let you exert direct influence through your funding. Buyer beware! As I’ve again covered in past videos, piling into isolated ventures comes with a lot more investment risk than taking a globally diversified approach.

So, where does all this leave an investor who wants to invest ethically and effectively? I like how financial journalist Robin Powell positioned it in :

“For those who want to invest in a way that is both evidence-based and ethical, the best option is probably to choose a low-cost passive provider with an effective corporate governance committee and a proven track record of holding company boards to account.”

In other words, look for low-cost, passively managed ESG fund managers to help you: (1) Build a globally diversified basket of holdings, which (2) have been sensible screened for best- and/or worst-case players, and (3) incorporates an element of “shareholder power” to encourage responsible behaviour among the companies that remain.

In my next post, I’ll take a closer look at what that might look like. Follow me on LinkedIn for more good stuff to come!