In keeping with general trends valuing the environment and social responsibility, investors have embraced “sustainable” mutual funds.
However, the definition and implementation of sustainable investment strategies varies. We believe it requires both screening and fundamental research.
Although it now has the trendy label “sustainable,” investing in companies that manage their business for the long term is in fact a successful, time-tested strategy.
In 1978, “Grease is the word” was the number one hit song. Today, we might say “Green is the word.” We recycle. We eat organic. We drink fair trade coffee from a reusable mug.
Even investing is not immune to the sustainability trend. The growth in mutual funds that describe themselves as sustainable or socially responsible has been impressive. In spite of the 2007-2009 bear market, financial crisis and Great Recession that scared many investors away from stocks in general, sustainable mutual funds have steadily increased assets, to a total of $3.74 trillion.*
The definition of sustainable investing is somewhat flexible. Generally, it means considering environmental, social or corporate governance factors when selecting companies or industries in which to invest. Sustainable Investing LLC suggests screening companies in or out of portfolios based upon four criteria:
- The first is a negative screen. Companies in certain industries, such as tobacco or mining, are excluded.
- The second is Best-in-Class rankings. Companies that score highly in sustainable initiatives are considered for investment.
- The next screen is Sustainability Leaders Only. These are companies make a commitment to work towards sustainability.
- The last group is the Pioneer Companies. These companies are the problem solvers that work towards a more sustainable future.
While these criteria seem pretty straightforward, the execution of a sustainable strategy is often a matter of subjective opinion. According to Lipper, 95% of the companies in the S&P 500 are represented in a socially responsible mutual fund. And a SmartMoney study found that half of the top 20 non-faith-based socially responsible funds owned oil companies.** Clearly, if you really want to invest assets in a manner consistent with personal values around sustainability, you must look beyond the simple label of a fund as “sustainable” and examine the process behind it.
Sustainable investing is more about investment culture than simply running screens and executing buy orders. An interesting point to consider is manager compensation. Is your portfolio manager of your sustainable fund incentivized correctly? Is their compensation tied to investing over a three-year or five-year market cycle or beating the market over the next three to five weeks? If they are compensated for the long term they tend to invest in companies that invest for the long term – that is, sustainable businesses.
Sustainable investing requires research. Screens may be used as part of the process but if they are “the process” they often fall short. For example, a company may have a policy that deals with the rights and well-being of its employees and check the box on a socially responsible screen. Without a research analyst checking into the company’s employee turnover relative to peers, its benefits packages, it average employee tenure, its training and advancement record and the diversity of its workforce, the policy is nothing more than a flyer hanging in the employee break room.
Ultimately, sustainable investing is more than a feel-good label. It’s smart investing. Companies that are good stewards of capital, value their employees, don’t cut corners on environmental issues and treat their shareholders as partners have tended to outperform the market over time because they tend to create leading products and have strong enough balance sheets to weather downturns.
A real sustainable investing strategy requires a combination of screening for companies that do the right thing and with strong fundamental research that verifies that they do. It’s not a fad and it is not new. It’s investing for the long term in companies that invest in the long term.
*Forum for Sustainable and Responsible Investment, Report on Sustainable and Responsible Investing Trends in the United States, 2012.
**SmartMoney Magazine, “Secrets of Socially Responsible Mutual Funds,” January 11, 2011.