A helpful way to think about the range of approaches is as a spectrum that runs from conventional investing all the way through to philanthropy.
At the first end of the spectrum, conventional investing falls out of the scope of sustainable investing, because it mostly doesn’t consider environmental, social and governance (ESG) issues.
At the other end of the scale is philanthropy. Philanthropy isn’t considered sustainable investing, because it is less about investing and more about giving.
In between conventional investing and philanthropy are five approaches you can consider as a sustainable investor.
1. ESG integration
When investment professionals say that sustainability is a core part of their investment process (as many do these days), what they are really saying is that their analysis includes some assessment of the financial risks of environmental, social and governance factors to the companies they are considering investing in.
For many Canadian investors who are looking to take a sustainable investing approach, this might feel too close to conventional investing to really meet their needs. What’s at stake here is how aware a company is of the relevant risks to its business, and how well it is managing them. All good stuff. But a company scoring highly in this regard may still be doing things that we don’t feel are “responsible” or “ethical.”
2. Negative screening
This is traditional “ethical” investing. It is about avoiding or excluding companies doing things that are considered questionable – things like weapons manufacturing and trading, tobacco sales, the publication of pornography, the extraction of fossil fuels. Where you draw the line on this list is a matter of personal values.
There can also be a risk management dimension to negative screening strategies. For example, changing values or regulatory shifts may mean that the oil and gas business is in long-term decline. Its cost of capital may rise over time. Many of the reserves booked by energy companies may never be exploited. These are all real financial risks that can potentially be avoided by using an exclusionary approach. But ultimately, exclusion is most often a moral question.
3. Positive or best-in-class screening
This is the flip side of exclusion. Best-in-class screening involves looking for companies that score well on environmental, social or governance factors. Again, this can have either a financial or an ethical focus. And increasingly, the evidence is mounting that the two concerns are inseparable. Analysis by Fidelity International has demonstrated that companies that score highly on ESG factors have outperformed in both down and up markets in 2020. A good ESG score is a kind of proxy for quality. Companies that understand the forces shaping the world around them and respond appropriately are, by definition, better companies. And investors are increasingly rewarding them with a higher valuation and a lower cost of capital.
4. Thematic/sustainability themed
This category sits right in the middle of the sustainable investing spectrum. Accordingly, a fund in this group might have more of a profit focus or might be more concerned with ethical values. You will need to look under the hood, read the objectives and be satisfied that the manager’s interests are aligned with your own.
Investing in a sustainability theme does not necessarily mean you are committed to changing the world for the better. It might just mean that you have seen which way the wind is blowing (literally, in the case of renewable energy) and recognized the long-term investment opportunity a sector or theme represents.
5. Impact investing
The final category is arguably the most interesting to those investors who see their money as a mechanism for creating a better world. As the name suggests, it includes funds that invest in companies that are targeting social and environmental improvements. It might, for example, include investments in social housing or businesses that are trying to create jobs for ex-offenders.
And there is a spectrum within the spectrum here, because funds may have differing demands of their investments with regard to the financial returns they deliver alongside their ethical impact. Again, it’s your decision as an investor how far toward philanthropy you want your impact investing to veer.
This is obviously a simplified view of a pretty complex picture, and not all funds will fit neatly within one category. An impact fund may apply negative screening as well, for example. Hopefully, however, this provides a starting point for your exploration of the world of sustainable investing.
Want to learn more about sustainable funds? Check out the following funds from Fidelity:
ESG Strategy: Best-in-class and exclusionary screening
Fidelity Sustainable World ETF and Mutual Fund is a global multi-factor equity strategy designed to provide strong risk-adjusted returns by investing in companies with favourable environmental, social and governance characteristics.
ESG Strategy: ESG Integration and thematic
Fidelity Women’s Leadership Fund is a core U.S. equity strategy that aims to deliver strong risk-adjusted returns by investing primarily in companies that prioritize and advance women’s leadership and development across their organization.