Socially responsible investing — also know as ethical, green or sustainable investing — is the new buzzword in the financial world.
A growing number of institutions and individual investors seem to want to invest according to ethical principles, and the financial industry has been happy to oblige.
Today, investors can choose from a smattering of investment options that carry some variation of the sustainable label.
By one tally, sustainable investing has now grown to an eye-popping $31 trillion globally, and it’s easy to see why.
The industry’s pitch is very persuasive: sustainable investing is as good for your wallet as it is for your conscience.
But are sustainable investment products as good a deal as the hype would suggest?
Does sustainable investing pay off?
Whether investing sustainably means sacrificing financial returns is the subject of debate among analysts and investment advisors.
Benjamin Felix, portfolio manager at Ottawa-based PWL Capital, for example, says both the data and the theory point to sustainable investments having lower expected returns.
As more and more investors buy up the stocks of companies deemed to be “good,” they push up the price of those shares, which necessarily reduces the returns investors can expect in the future, Felix said.
And because sustainable investors are guided by moral principles rather than mere financial metrics, they are less likely to ditch their underperforming sustainable stocks, which means their shares will stay overpriced.
Sustainable investors also necessarily have fewer investments to choose from, something that limits their ability to diversify their portfolios and diminish the risk tied to any one company or industry, Felix noted.
In addition, opting for sustainable investments often comes with higher fees, which eats further into returns, he added.
Tim Nash, an independent financial planner and founder of Good Investing, offers a different take. A preference for sustainable companies, he argues, steers investors away from corporations that may become the target of government sanctions or consumer boycotts.
Felix agrees that a company’s track record on issues like the environment and human rights can have an impact on the corporate bottom line. However, he believes the market is already quite good at pricing in those risks.
But Nash thinks sustainable investors are, in general, quicker to recognize that sustainability issues can have an impact on profits.
They are “ahead of the curve in recognizing these intangible values both on the upside, in terms of reputation, customer acquisition and employee attraction and retention … and also from the risk side.”
And while sustainable investing does come with less diversification and often higher fees, there are still plenty of investment options to choose from, Nash says.
Are sustainable investments actually sustainable?
Felix’s biggest reservation about sustainable investing is the criteria the industry uses to quantify sustainability, otherwise knows as ESG metrics.
The “E” stands of “environmental,” reflecting corporate conduct on issues such as carbon emissions and water pollution. “S” is for “social,” which looks at factors such as how a company manages its workforce and the labour practices in its supply chain.
The “G,” finally, stands for “governance,” or how a company governs itself, which includes issues such as who sits on the board of directors and how executives are compensated.
With a number of data providers compiling their own ESG ratings and indices, there are a number of different definitions and methodologies out there, Felix says. This can lead to confusion for both companies and investors, he adds.
“If companies are not clear on what ‘socially responsible’ means and what’s going to be rewarded, then it’s going to really [be] for them to know what to do to get a better rating,” he said.
On the investor side, some may not realize that plenty of investment products sold as sustainable involve exposure to oil and gas companies, Felix notes.
“You better know that what you’re investing in is actually reflecting your views and values because there’s a good chance it’s not,” he said.
Nash believes that ESG investment products, as imperfect as they may be, still help move the needle in the right direction. But he agrees with Felix that investors shouldn’t buy into sustainable investments without looking under the hood.
“Don’t do it blindly,” he said. “You need to do your homework.”