Sustainability concerns, particularly around the climate crisis, are on the agendas of regulators around the world and have gained influence in Washington with the new administration.
If you are considering adding a sustainability lens to your investments in 2022, here are four things to keep in mind about sustainable investing.
1) Sustainable investing is not just one thing: It represents a range of specific investment approaches.
Sustainable investing is not a singular approach but instead represents a range of methods that investors can use to generate competitive investment returns while helping generate positive outcomes for people and planet.
Our Sustainable-Investing Framework describes six distinct approaches to investing with sustainability in mind. Any given sustainable fund may use one or a combination of these approaches. In addition, these approaches are used in conjunction with standard investment practices that emphasize things like style, quality, or momentum.
The Morningstar Sustainable Investing framework.
What does this mean for you? It's important to take the time to understand what's under the hood. Do not assume that funds with names that include terms like "Sustainable" and "ESG" are identical investments. A good example is the treatment of fossil fuel exposure in sustainable funds. Some funds avoid such exposure altogether. Others have "best-in-class" environmental, social, and governance standards for fossil fuel companies to make it into their portfolios. Many of the funds that do include fossil fuel companies have ramped up their engagement with those companies to press them to reduce emissions. Some fixed-income funds may purchase green bonds issued by fossil fuel companies to help them finance renewable energy projects. And funds focused on renewable energy may have a lot of exposure to fossil fuel companies that are making major investments in renewables.
2) Sustainable investing continues to evolve and innovate.
Sustainable investing is connected to bigger-picture global changes. We are moving from an era in which most investors were OK with public companies making money for them while also generating negative social or environmental consequences, to one in which investors increasingly expect companies to make money while avoiding such costs or generating positive impacts. Rather than focusing solely on how ESG risks may affect an investment, more sustainable investments are also assessing the impact of an investment on people and planet. Innovations include funds focusing on improving corporate behavior through deep engagement and proxy voting, and funds starting to apply net-zero criteria to their investment selections.
ESG is not about sin stocks
3) Sustainable investing should deliver competitive investment performance.
Sustainable investments should be expected to generate competitive long-term performance. Sustainable investors should neither expect to always outperform nor to always underperform, but they should expect investment returns that are competitive with those of conventional investments. It has been hard to bust the myth that sustainable investments underperform. That certainly hasn't been the case during the past few years when, on the whole, sustainable funds have performed better than conventional funds. Keep in mind that returns of sustainable funds are not determined solely by the use of sustainability criteria, but also by other investment criteria employed by fund managers, so it's hard to sort out the relative effects of each on performance. That's why I recommend evaluating a sustainable fund's overall performance holistically and compare it with that of all funds that invest from the same broad asset class or investment category.
Sustainable investing is about profits, not taking a stand
4) Sustainable investments are primarily returns-focused, but they can have broader impact.
Sustainable investing is primarily about investing, not social or environmental activism, but it does have impact on the world. You may be attracted to sustainable investing because of your own social or environmental concerns, but the main focus of a sustainable fund is to generate competitive investment returns to help you reach your financial goals. That said, by making a sustainable investment, you are having more impact with your money than if you invested in a conventional way.
Sustainable Investing helps achieve Stakeholder Capitalism
