Climate change has been on a lot of people’s minds in recent years – consumers and companies alike. In November, the United Nations’ Emissions Gap Report 2019, which tracks global progress toward emissions goals, painted a bleak picture and set up 2020 to be a crucial year in fighting climate change.
“Our collective failure to act early and hard on climate change means we now must deliver deep cuts to emissions – over 7 percent each year, if we break it down evenly over the next decade,” said Inger Andersen, UNEP’s Executive Director, in a statement released with the report.
It’s cool to be a conservationist now. We’re constantly bombarded with new ways to be sustainable, new products and services that will save the planet. But in all the hype, ethical investing can get ignored. It’s not an aesthetically pleasing way to save the earth. You can’t post about it on Instagram. Ethical investing isn’t as cute as leggings made from recycled bottles, or as flashy as turtle-friendly metal straws. It isn’t as life-changing as going vegan. Ethical investing is less tangible than other actions people might take to further a cause of their liking, but it’s a real way to use your power as a consumer to influence companies to be more sustainable.
What is Ethical Investing?
Basically, a company can be rated based on its environmental, social, and governance (ESG) qualities. These ratings are supposed to indicate how ethical and sustainable a company is for investors. There aren’t standardized ESG guidelines, so there isn’t a uniform ESG scoring system.
There are many third-party providers of ESG scores, which all use slightly different criteria. The Harvard Law School Forum on Corporate Governance and Financial Regulation offers an overview of some of the big players.
If you’re a consumer, trying to figure out a company’s ESG score can be tricky. The easiest method I found was Yahoo Finance, which uses scores from Sustainalytics and offers a “sustainability” for stocks. But there isn’t a one-size-fits-all option. “Therefore, an investor should and needs to define what environmental, social, and governance issues they oppose and the level in which they will tolerate the violation,” said Sid Ean, regional director at Lifetime Financial Advisors.
From ESG scores, investment advisers can create mutual funds, exchange-traded funds (ETFs), or entire portfolios that prioritize companies with high scores. For example, Vanguard offers two ESG ETFs that “exclude the stocks of companies producing adult entertainment, alcohol and tobacco products, conventional and controversial weapons (including civilian firearms), fossil fuels, gambling activities, and nuclear power.” Betterment offers a Socially Responsible Investing (SRI) portfolio that excludes stocks (but not bonds) of companies that were “deemed not to meet social responsibility criteria.”
“I would suggest first determining what the guidelines are for how you would want to invest. Work with a CFP(R) professional to outline parameters for investing. You can then screen companies by examining their governance policies found via public filings,” said Michael Kothakota, a financial adviser and CEO at WolfBridge Financial.
For an even more personal approach, financial adviser Timothy Starkey says investors can customize their own indexes. “For example, they can start with the S&P 500 and screen out companies in the tobacco and firearms industries.”
The Historical Precedent
Disinvestment is nothing new. In 1971, the Rev. Leon Sullivan, an African-American preacher and a board member of General Motors, drafted a code of conduct (now known as The Global Sullivan Principles) to direct American investment in African companies as a response to Apartheid. His method of economic activism called for a more critical look at where American money was going and what it was really funding.
However, people have always argued that ethical improvements can only be made by sacrificing profit. In 1970, economist Milton Friedman argued that “the Social Responsibility of Business Is to Increase Its Profits” – also known as the Friedman Doctrine. Many investors were only interested in a company’s bottom line, not the moral implications of what produced it.
In 1984, Milton Moskowitz first published “The 100 Best Companies to Work for in America” with Robert Levering, where he argued that better business practices lead to more successful companies. The best companies, he felt, weren’t profitable despite being ethical. They were profitable because they were ethical.
Today’s Ethical Investor
With concern growing about climate change, the “E” in ESG is starting to get a lot more attention. In a recent survey from the Harvard Business Review, 65% of consumers said they want to buy from brands that advocate sustainability. And they have plenty of options; many brands, such as market disruptors Everlane and Blueland, have built their businesses around sustainable models. However, the same study found a significant intention-action gap: only 26% of consumers had actually bought from sustainable brands.
Some people feel living sustainably will be more expensive and requires sacrificing convenience and efficacy. In the age of cancel culture, it can be easier to cut out brands that aren’t ethical rather than adopt new brands that are. That’s why sustainable investing can be such a good option; rather than buying new things and changing your lifestyle to help the climate, you can just make changes to your investment portfolio.
Even so, it wasn’t long ago that financial advisers might have been shocked if you said you wanted to screen your portfolio for ESG scores. “If we were discussing this 10 years ago, my advice would have been to invest opportunistically and use the gains from the investment portfolio to lead an ESG lifestyle” Ean said. This might have been in part because there wouldn’t have been enough ESG-focused companies to build a successful portfolio around 10 years ago. Now, that certainly isn’t the case.
Why Invest Ethically
Three common arguments leveraged against sustainable products are that they’re too expensive, they don’t work as well, or they aren’t actually helping the environment. The good news is that ethical investments appear to be able to fight back.
If you’re already investing, you don’t need to spend any more money to make your portfolio more ethical. After doing your research to decide what ESG metrics you care about, and discussing it with a financial adviser (if you have one), you can reallocate your funds to different companies that better reflect your principles.
Gone are the days where a company’s only social responsibility is to increase profits. With pressure from consumers, many companies have started trying to improve their ESG scores. According to Trevor David, manager of client relations at Sustainalytics, “As the awareness of sustainable investing and Sustainalytics has grown, the company response rate and the quality of dialogue with companies has improved significantly.”
While there’s always an inherent risk in investing, studies suggest that ESG scores aren’t a big factor. Referencing a recent study reviewing ESG investing, Kothakota said “by and large, the differences in long-term returns have been found to be statistically insignificant.”
So will ethical investing make a difference? This one is harder to quantify. Ethical investors have to be optimistic that by voting with their dollar they’ll force companies to care about their own ESG scores. At the very least, investors may start to care a bit more about their portfolios if they have a moral interest in how it’s structured. It’s never a bad thing to take a critical look at how your everyday practices could be influencing the world around us.