Climate change is real, and the global response to this phenomenon is reshaping a host of different industries. But if you’re an investor who cares about the future, how can you be sure that you’re putting your money in assets that are part of the solution to climate change instead of “dirty” companies that don’t align with your values?
Furthermore, even if you can have confidence in a sustainable investing strategy, how can you make sure you’re not settling for an inferior retirement plan in the process?
As with so many things on Wall Street, the answers to these questions are complicated and depend in part on your personal financial goals. But the good news is that with a little bit of homework, it’s possible to engage with sustainable investing portfolio management in an effective way.
— What is sustainable finance?
— What sustainable finance metrics matter the most?
— What are ESG ratings?
— What is greenwashing?
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What Is Sustainable Finance?
The perils of putting profits above everything else should be clear to everyone. Whether it’s from real-life scandals like Bernie Madoff or the collapse of Enron, to fictional villains like Gordon Gecko who famously quipped that “greed is good” in the movie Wall Street, there’s no shortage of cautionary tales of capitalism run amok.
Sustainable finance is the catch-all phrase that refers to a different way of thinking. It involves assessing the environmental and social justice impacts of financial decisions. A focus on sustainable finance can happen in different ways, but from an investing perspective it generally means putting your capital behind companies you see as part of the solution — or at minimum, not part of the problem.
In the former camp of being part of the solution, the most common sustainable finance strategies for investors involve “inclusionary” indexes that identify leaders in certain areas. For instance, the $5 billion iShares Global Clean Energy ETF (ticker: ICLN) is an exchange-traded fund, or ETF, that requires a certain percentage of a company’s revenues to come from sustainable energy-related operations. The portfolio of roughly 100 stocks includes solar companies such as Enphase Energy Inc. (ENPH), wind turbine companies such as Vestas Wind Systems AS (VWDRY).
On the other hand, there’s still value in identifying companies that may not be innovative but simply are not making things worse. This is illustrated by “exclusionary” funds that most commonly cut out things like firearm companies, coal miners or firms involved in arctic oil and gas exploration. The iShares ESG Aware MSCI USA ETF (ESGU) is the gold standard of this group, with a massive $20 billion under management. The portfolio doesn’t look as oriented toward sustainability as the prior fund, however, with iPhone maker Apple Inc. (AAPL), e-commerce giant Amazon.com Inc. (AMZN) and insurance company UnitedHealthGroup Inc. (UNH) among the top holdings. However, these companies are on the list because of what they don’t do. Namely, they don’t sell guns or produce “dirty” fossil fuels.
What Sustainable Finance Metrics Matter the Most?
What makes sustainable investing portfolio management complicated is that there are dozens of other funds out there beyond these two leading investments from iShares. And, unfortunately, there’s no “right” way to measure sustainability — or the lack thereof — via a universally accepted system of measurement.
That means it’s up to individual investors to decide what approach fits best.
If you care about clean energy, maybe the aforementioned iShares Global Clean Energy ETF is a good fit on the surface. But if you pop the hood and look at the full list of 100 stocks in this ETF, you’ll also find publicly traded utilities like Consolidated Edison Inc. (ED) that generate a decent percentage of energy from traditional sources as well as renewables.
Is that really the kind of investment you intended on backing? If not, you may need to find an alternative investment vehicle.
If you want more of a pure play on alternative energy, maybe you go all in on a solar ETF instead like the Invesco Solar ETF (TAN). There’s admittedly more volatility in a fund like this, as it’s a focused play on solar technology. But with holdings like Enphase Energy, First Solar Inc. (FSLR) and SolarEdge Technologies Inc. (SEDG) you can be sure no fossil fuels are sneaking in the back door.
Or maybe you’re interested in electric vehicles both because of the green nature of these products as well as the megatrend that could result in big profits. In that case, the Global X Lithium & Battery Technology ETF (LIT) could be worth consideration. This $4 billion Global X ETF is designed to play battery technology and related infrastructure. That includes the Powerwall integrated battery system offered by Tesla Inc. (TSLA) which provides backup protection as well as electricity when the sun (or the power grid) goes down.
Each of these options offers a different approach. And deciding which one is best is entirely up to you, your investing goals, and what kind of sustainability flavor you’re looking for.
There’s a lot of flexibility in the exchange-traded funds marketplace for sustainable investing strategies. But that’s both a blessing and a curse, as it creates a need for investors to be thoughtful about what they are buying.
[READ: ESG Investing Trends for 2023.]
What Are ESG Ratings?
The move towards sustainable finance doesn’t just involve financing for green energy companies, however. It also involves a general corporate approach that acknowledges key issues for corporations in every sector.
This philosophy is known as ESG, an acronym for environmental, social and governance characteristics that go into a company’s strategy.
For instance, chipmaker Intel Corp. (INTC) has announced plans to achieve net-zero greenhouse gas emissions across its global operations by 2040. The manufacturing industry can be very carbon-intensive, so this corporate strategy would make INTC look better than some of its peers.
It’s not just environmental initiatives that matter to investors, however. There are many companies where women and minorities are underrepresented in senior management. If you have an eye toward the S in ESG, then it may be worth prioritizing companies like General Motors Co. (GM) and Citigroup Inc. (C) over their peers. Both have higher ratios of women in senior management than their peers, and Wall Street firms in general.
And then there’s corporate governance. Believe it or not, many publicly traded companies are not very accountable to their shareholders, thanks to either a large cohort of insider ownership or a dual stock structure that strips common stockholders of voting rights. Facebook parent Meta Platforms Inc. (META) is a good example of this, where founder Mark Zuckerberg owns more than half of the voting shares for the company — which means he can almost unilaterally do as he sees fit.
There’s an increasing movement on Wall Street to measure every piece of the ESG picture, and rank companies accordingly so investors can make informed decisions. Unfortunately, there’s no universally accepted measure of what the right rating system is, let alone what a “good” score is for companies.
That means, again, that it’s up to investors to learn more for themselves.
But here’s the good news: There are many firms out there working hard to refine the system right now. And whether you prefer Bloomberg’s ESG ratings or FTSE Russell’s ESG ratings or S&P Global’s ESG scores as your index of choice doesn’t matter much, as long as you understand what data those indexes are using to create their rankings.
It takes work, sure. But it’s easier than ever to find this information — and if you’re serious about sustainable investing, then it’s worth the time it takes to learn about this evolving area.
What Is Greenwashing?
While there are tons of sustainable finance investments out there and a wealth of information for interested investors, there’s also the risk of disinformation. That most commonly takes the form of “greenwashing” — or the practice of an organization marketing itself as environmentally friendly rather than actually doing the hard work necessary to address real sustainability concerns.
In fact, financial regulators are increasingly concerned with cracking down on this practice in financial markets. As proof, consider a May 2022 case against BNY Mellon Investment Adviser in which the firm “implied in various statements that all investments in the funds had undergone an ESG quality review, even though that was not always the case.” The firm agreed to pay a $1.5 million penalty as a result.
As mentioned before, there’s no universal rating system or disclosure process to provide some kind of consensus around whether an investment is “green” or not. So perhaps it’s not unsurprising that some firms simply engage in greenwashing or use their own sustainability-lite standards to simply put an ESG label on something, regardless of its real-world impact.
There are indeed worthwhile metrics out there for investors who are interested. However, the presence of greenwashing makes it incumbent on anyone interested in sustainable investing portfolio management to learn about what they’re buying, and which ESG ratings apply to the investments in question.
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What Is Sustainable Investing Portfolio Management? originally appeared on usnews.com
