Myth or Fact: Climate-Friendly Investments Can't Bring Returns?
Myth! The era of sustainable investing is here, ready to revolutionize your portfolio.
By Sydney Medd
October 8, 2024
Sustainable investing, often associated with environmental, social, and governance (ESG) criteria or impact investing, has gained significant traction in recent years. According to a 2024 report from Morgan Stanley, 96% of millennials are interested in sustainable investing. However, despite the increasing popularity, one question continues to grab the attention of interested investors.
Is it possible to balance profit and planet?
(Spoiler alert: yes, it is!)
What is covered in this article:
The notion that profitability and sustainability are at odds has been a significant barrier for those interested in green investment. A 2017 report by Morgan Stanley outlined that 53% of people worry that sustainable investing means earning less.
While this study dates back a few years, some misconceptions surrounding sustainable investing still exist, including:
Business leaders often perceive sustainable practices as slow to yield results and less focused on financials than traditional business practices. In the short term, this makes a sustainable approach seem less reliable than a traditional one.
Fact
Considering a company’s overall value proposition, including its contribution to society and the environment, can yield both financial good and positive impact. In fact, the same business leaders who associate sustainability with delayed benefits, also believe that business as usual is increasingly costly and complex.
Investors can actively contribute to sustainability by focusing on the triple bottom line approach in their investment strategies. This concept dispels the myth that prioritizing social and environmental considerations compromises financial returns. In fact, integrating the triple bottom line—measuring not just financial outcomes but also social and environmental impact—has transformed investor perspectives.
For instance, a 2023 series of reports by the Global Impact Investing Network (GIIN) found that most surveyed investors didn’t expect to sacrifice returns for values-aligned investing. In fact, 59% of investors reported that the financial performance of their impact investments met their expectations with 20% reporting the financial performance exceeded expectations.
This isn’t an isolated finding. Let’s look at more evidence:
- An earlier report aggregating performance data from over 1,000 studies found there is typically a positive relationship between environmental, social, and governance (ESG) performance and financial performance [1].
- More recently, a 2023 analysis by Morgan Stanley found that sustainable funds outperformed their conventional counterparts by nearly double in terms of median total returns [2]!
Many still view sustainable investing as a niche or passing trend, believing its primary motivation is altruistic or charitable.
Fact
Sustainable investing is here to stay – and it’s growing in popularity.
Far from a fad, sustainable investing is gaining momentum, with many investors believing it doesn’t compromise returns. A recent Morgan Stanley report found that nearly 80% of individual investors hold this view. This belief has fueled the growth of sustainable investing, as evidenced by the surge in assets under management (AUM) dedicated to this approach. Worldwide, AUM in sustainable funds doubled between 2017 and 2020 [3], and in 2022, sustainable investments accounted for 12.6% of the U.S. asset management market, totaling $8.4 trillion [4].
Climate change is a major factor driving this growth. According to one report, climate action is the top-reported sustainable investing theme. As investors recognize the financial risks and opportunities associated with climate change, they're increasingly turning to sustainable investment strategies to align their portfolios with their values and long-term financial goals.
When it comes to your retirement accounts, some have questioned whether sustainable investing prioritizes personal values over financial returns, potentially violating a financial professional's fiduciary duty— that is, the legal obligation to act in a client's best interest. Some asset managers have even succumbed to this pressure by backtracking on their ESG commitments.
Fact
Climate risk is an increasingly important – and government sanctioned – consideration when it comes to your long-term investments. Recent regulatory changes have clarified that incorporating “collateral factors” – such as the environment – into investment decisions is permissible (and relevant), provided it doesn't compromise financial performance.
Some investors worry that terms like ESG, green, and sustainable are merely marketing strategies concealing rampant greenwashing.
Fact
While it's true that labels alone don't guarantee positive impact, dismissing all sustainable investing as marketing is an oversimplification.
Let's break this down:
Understand ESG's limitations
ESG criteria were initially developed for institutional investors to assess long-term corporate risk across environmental, social, and governance dimensions. This broad scope can lead to misalignment with individual investors' goals, particularly those concerned with environmental impact. For instance, an ESG-labeled fund may include companies with poor environmental records if they excel in social or governance aspects (in contrast, impact investing aims to generate positive, measurable social and environmental impact alongside financial returns). This disconnect highlights the importance of looking beyond surface-level classifications and understanding the multifaceted nature of ESG ratings.
Transparency is on the rise
- Regulatory Push: Governments are advancing initiatives for greater corporate climate impact disclosure. (e.g., SEC's climate disclosure proposal)
- Consumer Demand: There's growing public pressure for companies to provide comprehensive environmental impact data.
- Evolving Standards: While a common impact measurement standard is still developing, numerous data sources and analytical tools are available.
Increasing regulatory oversight of marketing claims
Authorities are working to curb misleading marketing in sustainable investing. For instance, the SEC has proposed stricter regulations on fund naming conventions to prevent misrepresentation of ESG credentials.
Data is empowering investors
- Tools like GreenPortfolio offer in-depth analysis of funds' environmental impact, helping investors see beyond marketing claims.
- When considering financial advisors, it's crucial to inquire about their impact strategies and methodologies.
While some skepticism is warranted, the sustainable investing landscape is evolving with increased transparency and regulatory oversight. Informed investors can navigate beyond marketing hype by utilizing available resources and asking probing questions.
Myth busted
Let's put these misconceptions to rest once and for all. Sustainable investing isn't just a feel-good strategy – it can be a smart financial move. We've seen that it's not slow or unreliable, but actually keeps pace with (and often outperforms) traditional investments. It's no fad; sustainability is here to stay, driven by real-world challenges and opportunities. Far from conflicting with clients' interests, it often aligns with long-term financial goals. And while there's some marketing hype (as in any industry), increased transparency helps investors separate genuine impact from empty promises.
The bottom line? By moving past these misconceptions, investors can embrace the reality that profitability and sustainability are not mutually exclusive – in fact, they increasingly go hand in hand, offering a path to financial success that also contributes to a more sustainable future.
But how exactly can you put this knowledge into action? Let’s explore some popular sustainable investing strategies.
While sustainable investing can be rewarding on many accounts, navigating the complexities of sustainable investing can be daunting. Green financial advisors play a pivotal role in bridging this knowledge gap, equipping investors with the insights and tools necessary to reach their financial and sustainable goals.
Finding a sustainable financial advisor is a great way to get started on your green financial journey. When working with an advisor there are several strategies you can choose, personalize, and pursue to reach your sustainable goals.
As sustainable investing has gained popularity, two approaches have emerged as leading strategies for climate-positive investing.
Negative or exclusionary screening, involves excluding specific sectors, companies, practices, or other issues from your portfolio based on a set of defined criteria, such as environmental or social considerations.
A popular exclusionary screen is for companies that are deemed vice stocks and fall into industries that could be considered unethical, such as tobacco, gambling, and firearms. It is important to note, exclusionary screening is a great complementary strategy to a broader “impact strategy.”
By avoiding investments in companies that engage in harmful practices, exclusionary screening aligns with sustainable investing principles. For example, investors can limit their exposure to entities that might face legal, reputational, or financial challenges.
How can you be certain that your investments aren’t inadvertently supporting fossil fuel projects? There’s a chance they’re also funding the major emitters, commonly known as “Corporate Behemoths.” GreenPortfolio can help you get a clear picture of the impact your money is making — consider checking your climate scorecard by signing up or logging in to our platform.
Positive or best-in-class screening focuses on selecting companies that excel in environmental and social performance relative to their industry peers. Rather than excluding entire sectors, this approach identifies leaders within each sector based on their positive characteristics.
By emphasizing companies with superior climate-friendly practices, best-in-class screening plays a crucial role in driving positive change within industries. These climate-aligned leaders consistently demonstrate resilience, innovation, and adaptability, contributing to their long-term success. And as investors increasingly recognize the value of ESG factors, companies with strong sustainability practices may attract more capital.
Just as you would engage an architect to help build your dream house, you should consider enlisting a financial advising professional to help construct your sustainable investment strategy. An expert can provide the knowledge, tools, and guidance needed to create a portfolio that aligns with both your values and your financial goals.
Finding a sustainable financial advisor is a great way to get started on your green financial journey. With proper research, a well-defined strategy, and the support of a sustainable financial professional, both your financial and sustainability objectives are achievable.
A solid plan can lead to financial stability, peace of mind, and contribute to a more sustainable future. GreenPortfolio’s advisor matching service is a great way to start your sustainable investing journey. Through our service, you can find vetted financial advisors who share your commitment to climate, allowing you to boost your wealth and help the planet’s health.
Remember, sustainable investing is not just about avoiding harmful industries – it's about actively supporting and profiting from the transition to a more sustainable economy.
Your future, your terms!
That includes finding banking and investment partners that listen to your climate priorities. Get paired with a financial advisor who shares your values!
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Footnotes
[1] This study was a meta-analysis, meaning that it analyzed existing research on the link between ESG and performance rather than examining specific investments. Therefore, it does not provide performance data for individual stocks, funds, or other securities.
To assess the relationship between ESG and financial performance, the authors of this meta-analysis examined results from over 1,000 research papers published between January 2015 and February 2020 on the topic. To account for methodological differences in the studies, analysis was divided by corporate performance (i.e., metrics reflecting successful business operations) and investment performance (i.e., measures of financial success). Results of the primary meta-analysis showed that (1) ESG is positively related to corporate performance and that (2) ESG investments show similar or better performance when compared to conventional investments (p5). An additional meta-meta-analysis of 15 existing independent meta-analyses from the same time period supplemented and supported the primary findings.
For additional details about screening criteria and methodology, please see p11 of the report.
[2] It is important to note that the findings reported in Morgan Stanley’s 2023 Sustainable Reality are based on a specific methodology and dataset (see p2 of the report for details). These factors should be considered when interpreting the report's findings. In summary, the analysis covers the performance of approximately 97,000 global funds between January 1, 2023 and December 31, 2023. Funds analyzed met Morningstar’s “sustainable” classification, which includes but is not synonymous with an ESG classification, see here for more information.
[3] As reported in Morgan Stanley’s Navigating the Next Decade, published October 2023: Between December 2017 and December 2020, assets under management (AUM) in sustainable funds doubled, reaching approximately $1.6 trillion. See report for additional details.
[4] According to a 2022 report by the US SIF Foundation, at the beginning of 2022 total US assets under professional management were calculated at $66.6 trillion and sustainable US assets under professional management were calculated at $8.4 trillion. Compared to past years, the 2022 methodology included more stringent criteria for what counted as “ESG.” For this report, analysis criteria distinguish between firm-wide ESG references and fund-level strategies. Only funds that specifically identify ESG as part of their investment process are included in the total ESG AUM.
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