Sustainable Investing - Unsustainable Trend or Future?
There is no disputing the fact that money is flowing into sustainable investing funds at a record rate. The pandemic has only confirmed this movement and accelerated its growth. Despite the data, there are still skeptics. Some still view sustainable investing as just another “fad” or financial marketing scheme. Others believe the growth is only because of the number of funds that are simply re-branding themselves as Environmental, Social and Governance (ESG) friendly. Although it is wise to remain skeptical about your investments, it is equally important to follow the research. There are a few financial analysts and economists that understand the inherent reasons behind sustainable investing. They recognize this as a shift in how we allocate our valued and scarce dollars. They, also, recognize the power of sustainable investing.
Sustainable investing had its beginnings in “Socially Responsible Investing.” This, typically, meant excluding certain products or companies from your investment portfolio. There are several examples, but one of the most often used is the tobacco industry. Once it became scientifically and socially clear what the health and other related costs of smoking were, the market incorporated this into the value of the industry. Tobacco companies became directly accountable for some of the nonfinancial costs of their products. This led to the demise of some companies and the significant downgrading of others. It made financial sense to divest from these previously overvalued stocks no matter what “type” of investor you were.
With the understanding that a company’s worth is based on more than just its “traditional” fundamentals, analysts started to incorporate environmental, social and governance (ESG) factors into their valuations. It soon became apparent that these factors were good predictors of both positive and negative performance. ESG contributed to a more comprehensive view of a company and the overall process of allocating resources – the economy. This has and will, overtime, lead to incorporating full cost accounting and new sustainable economics’ models. Adding new factors, such as ESG, into your financial analysis are important to consider in creating sound investment strategies.
Using this new sustainable model, the next question is how do we more efficiently allocate our resources in the marketplace? The answer has been impact investing and maximizing our sustainable return on investment (SROI). Impact investing incorporates multiple stakeholders’ interests beyond shareholders and owners to include employees, customers, suppliers, and affected communities. It uses full cost accounting, SROI models and expanding financial theories. The goal is to use financial markets to create solutions to critical threats facing the world. We are seeing this play out during the current pandemic. The energy industry is another good contemporary example. As we become aware of the true environmental, health and other costs of extracting and expending fossil fuels, the worth of the traditional energy industry decreases as the value of the alternative energy field rises. This seems intuitive since the value of an industry or price of a company’s stock is based on its future performance not on the past.
So, is this a trend or the future of investing? Is Sustainable Investing based on solid reasoning or current emotions? Do you believe that the value of the tobacco industry or fossil fuel industry will someday rebound? If you do, then this is just a trend. However, if you believe that we will continue to incorporate ESG and other factors into our valuation methods, it signals the future of resource allocation and investment. Investments that will fundamentally change the world.