Why is sustainable investing important? Sustainable investing is important because it can both mitigate investment risk and support companies taking active roles on key issues such as climate change and social justice. Sustainable investors look for opportunities and financial return in companies with high environmental, social, and governance priorities.
“Sustainable” can also mean self-sufficiency or stability in the long term. Companies mitigating risk through good governance or whose business practices limit climate vulnerabilities would fall under the umbrella of sustainable investing.
Investors have the power to leverage their funds to change business priorities and increase awareness on environmental, socially responsible, and governance issues. Sustainable investing, also called impact investing or ESG investing, can be a strategy to create a positive social and environmental impact while building long-term wealth.
Although 83% of millennial investors believe the myth that sustainable investing brings a performance trade-off, interest in sustainable investment continues to grow. According to Morgan Stanley’s Institute for Sustainable Investing 2021 report, 79% of all investors and 99% of millennial investors -- the latter an all-time high -- reported interest in sustainable investing.
With the current bear market, there is another important reason sustainable investments are prioritized in asset management: Sustainable funds have shown greater resilience in economic downturns. Investors can use sustainable and responsible company actions as an additional screening tool when building investment portfolios.
In terms of performance, 61% of Morningstar’s ESG-screened indexes beat their market equivalents in 2021. Sustainable investing can be a strategy to build long-term wealth and reward companies moving toward the triple bottom line of doing good for people and the planet while increasing profits.
What is sustainable investing?
Sustainable investing is investing in companies that prioritizes environmental stewardship, social responsibility, and good governance. Used interchangeably with ESG investing, one approach to sustainable investing looks at a company’s ESG rating for overall sustainability impact and balances ESG risks with potential returns.
Other sustainable investors use a discretionary approach to filter for companies that don’t meet certain ESG criteria. Investors commonly filter to avoid companies that produce fossil fuels, weapons, nuclear power, tobacco, adult entertainment, or other controversial products.
Impact investing, also used interchangeably with sustainable investing, often centers on one cause or objective, such as the climate, rather than broad ESG criteria. ESG impact investors may prioritize companies taking targeted action to reduce carbon impact or combat social injustice.
Why invest sustainably?
Sustainability is more than idealistic: It offers an investment process that can build stable, long-term returns while making an environmental and social impact. If you’re ready to branch out, here are four reasons why every investor should consider investing at least some portion of their portfolio in companies with sustainable priorities:
Increased returns
For more than 20 years, companies with high ESG values have shown consistent resilience and growth. Even through the economic stress of the COVID-19 pandemic, ESG stocks had above-market returns. A few highlights:
- According to Morgan Stanley’s 2021 Institute of Sustainable Investing report, the relative performance of sustainable and traditional U.S. equity funds showed no financial trade-off in performance from 2004 to 2020. In fact, sustainable funds outperformed traditional funds.
- Along the same lines, the S&P 500 ESG Index has outperformed the broader S&P 500 at reporting periods for the past 10 years.
- In 2021, Morningstar’s broad 373-stock U.S. Sustainability Index had returns that were 3% better than the overall stock market, with a 29.1% return.
- Also in 2021, the 50 U.S. companies with the best ESG scores as rated by Sustainlytics beat the broader U.S. market by more than 8%, with a return of 33.3% for the year.
Decreased volatility
ESG funds have shown historical resilience during market downturns such as the 2008 and late-2018 stock market collapses, as well as 2020’s market contraction. Companies with strong ESG priorities have also shown greater ability to bounce back.
Sustainable investors are looking to ESG investments as a buffer against the current market downturn and possible recession. Predictors such as good governance, clear supply chains, and lower environmental impact or vulnerability protect companies from ESG-related risks that can increase long-term volatility.
Long-term trends
According to Morgan Stanley’s 2021 report, 99% of millennials showed interest in ESG investing. That generation is set to inherit an estimated $27.4 trillion, mostly from baby boomers. With the generational transfer of wealth and shifting sustainable priorities, investors can expect to see more companies prioritizing ESG, as well as more rigorous and reliable sustainability metrics.
Companies with sustainable priorities 25 years ago have shown sustained growth. With shifting demographics and both consumer and investor interest, it's reasonable to believe buying and holding ESG exchange-traded funds (ETFs), mutual funds, stocks, and bonds could show even greater growth in the next 25 years.
Making an impact
The bottom line is the paragon of sustainable investing. Done well, investors earn excellent returns while creating positive changes in important issues such as climate change and social justice. Investors can help to change the world, and it is an important time to drive societal change through investment dollars.
According to Morgan Stanley’s 2021 report, 93% of individual investors who believe the economy is strong expressed interest in climate-themed investments. According to the same report, 60% of all investors are interested in a solution to climate change.
While recent turbulence may mean more investors have concerns about the strength of the economy, interest in ESG and the urgent need to curb climate change are still driving investors to make a difference. The war in Ukraine has highlighted the desire to find where private capital can make an impact in the world.
Screening sustainable investments
ESG reporting offers insight into a company’s ESG or sustainable priorities. However, without a standard ESG reporting framework, these reports can be biased since they are often produced by the companies themselves.
ESG ratings measure a company’s overall long-term environmental, social, and governance risks. The widely-used MSCI USA ratings system measures industry-specific issues that are then weighted by potential impact. The industry-specific and weighted scores combine to give each company a score between 0 and 10, which is then converted to a letter grade between CCC and AAA. Sounds complicated? It’s actually fairly simple: The most sustainable companies have a score of AA or AAA. A score of BB is average. Investors can look at the details of the MCSI report to see an individual company’s risk profile.
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The future of sustainable investing
Sustainable investing is important because it can be a tipping point to drive change on complex issues such as carbon emissions and living wages. Although the solutions are not simple, investor interest in sustainability has the power to turn the tide.
Sustainable investing could play a larger role in the future. Expect new companies entering the sustainability space as investor demand leads to fundamental changes. We could also see a standardized ESG reporting framework and more detailed ESG ratings that improve assessment of a company's priorities.
The fundamentals of traditional investing and sustainable investing are the same. Sustainable investing adds the element of global impact that could become the new paradigm of investing standards. With sustainability screening tools, it’s possible to make a positive impact while earning long-term, stable returns.
