In simple terms, sustainability is defined as achieving economic prosperity while simultaneously leaving no impact on the planet. Our planet would be no worse off after this prosperity is achieved than before. With all the environmental and geopolitical events surrounding us today, sustainability has become a focus of much of the private sector and has also become a buzzword on Wall Street.
Sustainability can be measured within the corporate world via three main factors: Environmental, Social, and Governance, or ESG, for short. Today, the private sector is starting to integrate ESG-related initiatives into its corporate philosophy more and more. This is not only because these particular companies may care more about our planet than before, but also because it may be of interest to their shareholders. While there has not (yet) been a proven link between sustainability practices and share price performance, it is becoming more prevalent in the financial markets today. Sustainability practices can reduce a company's operating costs, thus increasing its bottom line, and just as importantly, these practices can increase a company's brand equity, providing a competitive advantage that wasn't previously apparent. It is fast becoming a new way to differentiate oneself in today's marketplace.
Wall Street has also begun to pick up on a company's ESG philosophy. For example, Goldman Sachs (GS), a long-time leader in sell side equity research, has begun to include ESG criteria in its sectoral coverage, as outlined in its Environmental Policy Framework. Goldman Sachs has devised a way to quantify such initiatives into its equity recommendations, and this should prove to be especially important in the high environmental impact sectors such as oil & gas, utilities, airlines, and automobiles. Additionally, there are advisory firms that are dedicated exclusively to researching ESG initiatives within companies, and these firms have developed their own proprietary rating systems as to which companies are the most sustainable. Commonly known as "extra-financial research", this type of research provides an important supplement to the traditional research needed to make the most educated investment decisions. The Innovest Group and KLD Research & Analytics are two of the leading investment advisory firms in this space. They recognized the importance of sustainability years ago and are now poised to continue to help pioneer this new era of socially responsible investing (SRI).
On the buy side, there are more and more equity funds entering the marketplace that integrate ESG-related themes when choosing their constituents. These funds will only include companies that have demonstrated a certain level of sustainability in their corporate philosophy. Additionally, they may choose to screen out altogether certain companies that are in particular "sin" sectors such as gambling, tobacco, weapons, etc. It is all up to the fund manager to decide which particular values the fund will incorporate, and then it is up to you, the investor, to decide which particular values you want to invest in. Today, there are more options than ever to choose from, so be sure to do the research to pick the appropriate investment for you. To get a sense of which companies have set the bar in the sustainability era, a good place to start is The Global 100, an annual list of the world's top 100 most sustainable companies, as selected by Innovest.
So who has created such funds? Quite a few money managers run SRI funds these days, and a few examples include Parnassus, Calvert, Pax World Funds, and Domini Social Investments. Check out their websites to get a sense of how their money management philosophies differ from most traditional mutual funds. Also, be sure to check out SocialFunds.com as a good starting point for research in this space.
Now that socially responsible investing has gained a foothold in today's financial markets, let's hope that it is here to stay. At the end of the day, what will determine whether a given business has staying power is its performance. This begs the following question: are SRI funds guaranteed to overperform traditional funds?
No, they are not. At this point, there is no proven link between social responsibility and performance. And it will also be a while before we can accurately assess that hypothesis. While certain SRI funds have been in the marketplace for years, the SRI niche hadn't really been refined enough in the marketplace until a few years ago where we could start (fairly) comparing its performance against other funds. And just a few years worth of data won't give an accurate assessment either. I'd like to give a good 15 years worth of data points before a proper comparison can be made.
But while the jury is still out on whether you will gain superior excess returns by investing in an SRI fund, that doesn't mean we can't all be stewards of our planet in the meantime and start looking into such funds now. Take a look around, there likely is a fund already that will suit your tastes. If not, there soon should be.
Disclaimer: I do not give investment advice. Do your own research. Do not rely on anything in this weblog to make investment decisions. I only write about investment opportunities that I think are interesting. Consult an investment professional familiar with your specific financial situation before buying or selling any security.
Disclosure: Part of m IRA is allocated to an SRI fund and it will be for a long time.