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Sustainable Investing: More Than Tilting at Windmills

"Just then they came in sight of thirty or forty windmills that rise from that plain. And no sooner did Don Quixote see them that he said to his squire, 'Fortune is guiding our affairs better than we ourselves could have wished.'"

-- Part 1, Chapter VIII. Of the valourous Don Quixote's success in the dreadful and never before imagined Adventure of the Windmills, with other events worthy of happy record.

 

Driving through Spain this summer, we were mesmerized (quite literally) by the wind turbines that dotted the modern-day landscape of the fabled Don Quixote. A quick fact check and we learned that, as the fifth largest producer of wind power in the world, Spain produces over 20% of its electricity by wind.

Wind turbines in Cádiz Province, Summer 2017

Wind turbines in Cádiz Province, Summer 2017

Not only had we arrived in the land of Cervantes, but we were reminded of the dynamic nature of human innovation—in this instance, harnessing the wind for a cleaner, more sustainable source of energy. Such innovations can represent opportunities for investors to align with companies that promote sustainability or demonstrate sustainable business practices.

Sustainable investing—the term used for this kind of investment screening—considers the progress being made (or not made) toward addressing global challenges such as climate change, social inequality, and unfair business practices. It can be a powerful tool in addressing environmental or moral concerns while achieving personal financial goals.   

This is not to imply that other forms of investing are unsustainable; rather, a sustainable investing approach aims to equip investors with additional information for choosing investments that meet all of their goals.
        
What Is Sustainable Investing?

Sustainable investing describes investment strategies that incorporate environmental, social and governance (ESG) criteria into investment decisions to better assess risk and opportunities. These strategies usually seek to reach one or more of the following objectives:

  • Encourage positive environmental, social or governance practices
  • Align investments with personal values
  • Improve portfolio risk/return characteristics

It's Not Just About Feeling Good ...

Beyond achieving the peace of mind that your investments are having a positive impact,studies have shown that companies that operate in a sustainable manner provide better investment performance.[1]

There are many factors playing into why these companies may outperform, ranging from the ability to attract and retain better human capital to sourcing resources using sustainable means. There is a growing belief that companies that ignore ESG factors may become vulnerable to increased regulation or be required to pay punitive fines to governments.

The CFA Institute found that 63% of investors who take ESG issues into account in making investment decisions do so to help manage risk as a part of their long-term financial plans.[2]
         
Different Approaches to Sustainable Investing

While there is a common theme of pursuing a greater purpose, there is much variety within sustainable investment strategies, particularly in how they are implemented. Implementation generally takes the form of one or more of the following approaches:

Exclusionary screening

  • Viewed as the original approach to "responsible" investing
  • Also known as socially responsible investing or negative screening
  • Excludes individual companies or entire industries from portfolios if their activities conflict with an investor's values, such as fossil-fuels, gambling or alcohol
  • Limits investable universe, which could impact diversification

Integration

  • Combines ESG criteria with traditional financial considerations
  • Gaining momentum as portfolio managers consider ESG themes in their decision-making process
  • Sometimes implemented as a best-in-class approach by identifying and investing in companies that are the best ESG performers within a sector or industry group
  • A study conducted by the CFA Institute cites integration is the most commonly used method[3]

Impact investing[4]

  • Aims to have a social or environmental impact alongside financial return, with a focus on intentionality and measurement of impact
  • Ranges from grant support to private equity; liquidity risk and return target can vary dramatically
  • Most common products are funds invested in private equity and venture capital
  • Accredited investors and funds are the leaders in impact investment by asset level

Other dimensions

  • Thematic investing - focuses on a specific ESG theme, and structures a portfolio around companies or industries that support that theme
  • Shareholder engagement (activism) - actively engages with a company, directly working with management or exercising shareholder rights to effect change

Here it is presented graphically:

 
Sustainable Investing Spectrum.jpg
 

Why Investors May Consider Sustainable Investing

More and more we are seeing the investor mindset shift to embrace the idea that promoting effective global stewardship and achieving possible financial growth are not necessarily mutually exclusive. Invested dollars in sustainable or ESG investing reached $7 trillion in 2016, which is nearly double the 2012 figure of $3.7 trillion. And assets under management using these strategies account for more than one out of every six dollars under professional management in the United States.[5]

Among the reasons investors list for adopting a sustainable approach to investing are:

Risk mitigation - Companies that ignore their social and environmental impacts may face regulatory and governance risks.

More conscious approach to investing - Investors may aim for a positive impact or avoid ties to questionable activities.

Long-term performance - Companies with a negative reputation or poor business practices may not be sustainable.

Align investing with personal or religious values - Investors may not feel comfortable investing in companies whose business practices they view as morally objectionable.

Fiduciary duty - Professional asset managers have a responsibility to invest within certain standards that represent their clients' interests, which would likely make investments in companies with unsustainable practices less appropriate.

Through sustainable investing, not only can investors aim to make a positive impact on society and the environment, they can potentially improve the risk/return characteristics of their portfolios by factoring ESG criteria into their investment decisions.

If sustainable investing is something you would like to learn more about—or you would like to review your portfolio from a sustainability lens—please contact my office and let's schedule a time to meet.

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Adapted from the Raymond James whitepaper "Sustainable Investing Explained," 2016. Material prepared by Raymond James for use by its financial advisors.

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[1] Eccles, Robert G. and Ioannou, Ioannis and Serafeim, George, "The Impact of Corporate Sustainability on Organizational Processes and Performance." (November 23, 2011). Management Science, Forthcoming.

 [2]  [3] CFA Institute, "ESG Issues in Investing: Investors Debunk the Myths." 2015.

 [4] Global Impact Investing Network, "What You Need to Know About Impact Investing," https://thegiin.org/impact-investing/need-to-know/#s2

 [5] US ISF Foundation, "SRI Basics." 2015.

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Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC. Investment advisory services offered through Raymond James Financial Services Advisors, Inc. Estes Wealth Strategies is not a registered broker/dealer and is independent of Raymond James Financial Services.

Any opinions in this newsletter are those of Estes Wealth Strategies and John Estes and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice. 

There is no assurance that sustainable investing companies will meet these objectives. Investing involves risks including the possible loss of capital.

Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website's users and/or members. 

The information provided does not purport to be a comprehensive description of securities, markets, or other developments. This information has been obtained from sources considered reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information provided is not a complete summary or statement of all available data necessary for making an investment decision, nor does it constitute a recommendation.