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What You Need to Know About Ethical and ESG Investing

Alicia Schneider
April 20th, 2022

Ethical investments can be just as performant, if not more, than their conventional counterparts. Find out more about ethical investments and how you can add them to your portfolio

Investors are no longer interested solely in financial gain. Many investors are now equally as concerned with how their investments impact the planet, society, and our futures, wanting to invest in companies or products that aim to better the world. Over the last couple of years, there has been a sharp increase in ethical investing initiatives. Last year alone, ESG funds accounted for 10% of global fund assets.

Continue reading to better understand how ethical and ESG investing can fit into your own portfolio.

What Is Ethical Investing?

When it comes to ethical investing, how and where you invest your money is entirely dependent on your own personal values and ethics. For example, if you have certain religious values, you can search for faith-based funds where you’re able to invest in assets that align with the principles of your faith.

Sustainable investing, by contrast, is governed by a broad set of criteria that designates an investment or portfolio as sustainable. Often, sustainable investments rely on specific Environmental, Social, and Governance (ESG) criteria to evaluate companies to invest in.

As an investor, you might be discouraged by the additional criteria to consider when choosing ethical investment funds. Not only that, but a study by the Morgan Stanley Institute for Sustainable Investing shows that while interest in sustainable investing remains high, up to 70% of investors believe this type of investing comes with a financial trade-off. However, sustainably-managed assets in the US increased from $236 billion in 2020 to $357 billion as of December 2021. This 51% growth rate suggests that ESG funds can be just as profitable as conventional ones.

Types of Ethical Investing

Ethical investing is a broad term that covers a few different types of investing. In all these types of investing, the investor is also concerned with social, environmental, and ethical aspects beyond purely financial considerations. Let’s take a look at four main types of ethical investing.

1. ESG Investing

As mentioned earlier, an ESG investing strategy comes with certain criteria that are often represented in a rating out of 100. The score is based on multiple factors, such as:

  • Environment: how a company’s environmental output or policies impact the planet. This might include looking at a company’s carbon footprint, sustainability efforts, manufacturing policies, and more.
  • Social: how a company values local communities, employees, clients, or leaves a social impact. Some things to look at are racial diversity, the inclusion of minority groups like LGBTQ+, inclusive hiring, and others.
  • Governance: investors might also look at how a company’s leaders leave a positive impact, such as how leadership and non-leadership roles are compensated and whether there’s diversity in managerial roles.

ESG investing is quickly becoming the norm in certain sectors, namely real estate. According to a survey conducted by CBRE, over 75% of commercial real estate investors have adopted or are considering adopting ESG criteria.

2. Socially Responsible Investing (SRI)

While ESG investing focuses on different aspects of a company’s value system, the idea with SRI is that the type of business the company is involved in is considered socially responsible. Companies that deal in gambling, tobacco, alcohol, or fossil fuels, for example, would be excluded from SRI portfolios due to the nature of their products.

SRI doesn’t have a specific set of criteria like ESG, but rather it’s guided by an investor's personal set of beliefs. That being said, it’s not uncommon for investors to use ESG guidelines when considering what would be a socially responsible investment.

3. Green Investing

Also referred to as “sustainable investing,” green investing can be an element of ESG investing and SRI, but it’s a more specific way to decide which assets to take on. Essentially, investors who are interested in green investing will hold the environmental impact a company has in higher regard than other aspects, like their social impact.

While green investing does imply investing in companies that don’t have a negative environmental impact, it’s more targeted at funding companies that have a positive impact. For example, green investors might prefer to take on funds from companies that work with renewable energy sources, making water more accessible, conservation projects, and anything else that might be considered environmentally conscious.

4. Impact Investing

Impact investing follows a similar trend to the other types of ethical investing. It focuses on investing in businesses that have a positive impact. While that impact may be related to the environment or sustainability, it’s not a requirement. Impact investing can also focus on other industries, like education, healthcare, or funding non-profits.

What’s important to take note of with impact investing, along with other types of ethical investing, is that alongside financial reports that explain the earnings on your investment, companies are also meant to deliver reports on targets or progress towards their intended impact. In other words, as an impact investor, you will track how your investment is performing financially and how your investment has been used to reach a company’s social or environmental objectives.

How to Start Building Your Own Ethical Investing Portfolio

Aside from considering more ethical and sustainable investments, another common trend among investors is shifting from active to passive investments. However, with ethical investing, passive investing becomes more of a challenge due to the hands-on nature of selecting companies or funds to invest in, following up on their goals, and considering your own values when selecting where to invest. When building your own ethical investment portfolio, it’s important to first consider how active or passive you want to be throughout this process as this can dictate which type of ethical investments you choose.

In terms of putting together your own portfolio, you’ll likely need to start by spending some time researching potential investments. If you’re looking to be more active in your investments, you can search for individual stocks to invest in. However, if you’re leaning towards a more passive investment opportunity, you can look into various ESG funds or even ESG ETFs.

As far as how you gauge what investments are ethical or not, that’s mainly up to you. Start by creating your own personal list of investments you wouldn’t feel ethically comfortable with, and then another list of what types of initiatives you’d like to support. From there, you can do some research into various sustainable and ESG investments. While selecting potential investments for your portfolio, use tools like the Morningstar ESG Screener to find out an asset’s sustainability rating.

As with conventional investments, you still want to maintain a diversified portfolio when it comes to ethical investments. Seeking a mix of individual stocks along with mutual funds will ensure your portfolio remains diversified. For stocks, you can look into any public reports a company releases to see if its objectives are in-line with your values. Many companies release regular sustainability reports you can use to help you make a decision.

For mutual funds, you’ll want to consult with your broker for funds that match your personal criteria or the general ESG criteria. A great tool to use when adding ethical mutual funds to your portfolio is As You Sow. This website allows you to search for funds that you may be interested in or that are already in your portfolio. Each fund is allocated a score and you’ll also be able to see details such as if the fund has any holdings in fossil fuel companies as well as an overall environmental and social report card.

Final Thoughts

There is no longer any reason to shy away from ethical investing. In fact, more recent data and reports suggest that many ESG investments actually outperform conventional ones and also tend to come with less risk and volatility. When you’re ready to add ethical investments to your portfolio, be sure to update them in your Vyzer account as well so you can track their progress and see how they’re performing compared to your other traditional investments.