Responsible investing, also known as ethical or sustainable investing, is a philosophy and approach that aims to incorporate environmental, social, and governance (ESG) factors into investment decisions. The goal is to generate financial returns while also creating a positive impact and aligning investments with an investor’s values.

Key Takeaways:

1. Responsible investing aims to incorporate environmental, social, and governance (ESG) factors into investment decisions to generate financial returns while creating a positive impact.
2. It’s a growing trend, with $30 trillion now invested sustainably worldwide. Approaches include ESG integration, thematic investing, shareholder advocacy, and exclusionary screening.
3. The case for responsible investing includes meeting client demand, identifying future risks, enhancing portfolio returns, aligning investments with values, and getting ahead of regulation.
4. Challenges include limited options, higher fees sometimes, subjective choices, “greenwashing” concerns, and performance uncertainty.
5. Steps to get started include learning your priorities, asking your financial advisor about options, researching specific funds/products, comparing offerings, and starting small.
6. Responsible funds now exist across geographies, asset classes, and styles without systematic performance trade-offs compared to conventional options.

As consumers become more conscious of the environmental and social implications of their purchases, this mindset is now being applied to investing portfolios. A growing number of investors want to put their money to work in companies that engage in sustainable business practices and avoid industries perceived as harmful. The responsible investing trend has moved from a niche to the mainstream, with $30 trillion now invested sustainably worldwide.

This guide will provide an overview of responsible investing: what it means, its growth, the arguments for and against it, and how interested investors can align their money with their values.

What is Responsible Investing?

Responsible investing considers ESG factors – the environmental, social, and governance practices and impacts – of investment decisions. It is an umbrella term that encompasses overlapping approaches like:

• Sustainable investing: Considering how companies perform on ESG issues as part of the analysis. This can mean investing in sustainability leaders or excluding poor ESG performers.
• Impact investing: Proactively investing in companies, funds, and projects to generate social and environmental impact alongside financial return.
• Shareholder advocacy and engagement: Using shareholder power to influence company behavior through proxy voting, filing shareholder resolutions, and engaging directly with company management.
• Negative/exclusionary screening: Excluding sectors, companies, or practices deemed unethical or controversial from investment portfolios. Common exclusions include weapons, tobacco, gambling, and fossil fuels.
• ESG integration: Including assessment of material ESG factors into financial analysis of a company. This means evaluating whether ESG issues may pose risks or opportunities that can impact profitability.

A responsibly invested portfolio aims to align investors’ money with their values and priorities around issues like climate change, human rights, and corporate governance. According to US SIF’s 2020 Report on Sustainable and Impact Investing Trends, $17.1 trillion was invested in the US following one or more of these strategies as of year-end 2019.

As the variety of approaches shows, responsible investing appeals to investors with diverse priorities – from avoiding objectionable industries to seeking positive social and environmental change. What ties them together is the consideration of ESG factors alongside financial metrics.

The Case For Responsible Investing

1. Meet client demand – Surveys consistently show increasing consumer appetite for responsible investing in America. According to Morgan Stanley, 86% of millennial investors were interested in sustainable investing in 2019. And a 2020 survey by Nuveen found 77% of all investors were interested.
2. Identify future risks – Many ESG issues have the potential to impact profits and shareholder value. For example, climate change brings regulatory, physical, and reputational risks. Responsible investing helps identify these risks early.
3. Enhance portfolio returns – Hundreds of academic studies show responsible investment funds perform comparable or better than conventional ones. Companies with good sustainability practices have been shown to provide better operational performance and lower risk profiles.
4. Align investments with values – Responsible investing allows investors concerned about issues like climate change or inequality to avoid financing harmful industries and direct capital in line with their convictions.
5. Meet client demand and get ahead of regulation – Regulatory initiatives like the EU Sustainable Finance Disclosure Regulation require investors and managers to provide ESG-related disclosures. Adopting responsible investing now can help financial advisors meet impending requirements.

As client and societal expectations evolve, responsible investing principles enable better assessment of future risks and connections with shifting consumer priorities around ethics and values. Investors increasingly recognize money can support both financial security and social good.

Approaches to Responsible Investing

How does responsible investing work in practice? Portfolios can reflect ESG priorities through:

• Negative/exclusionary screening (avoiding investments in certain sectors, products or regions)
• ESG integration (considering material ESG factors among investment analysis)
• Thematic investing (targeting areas like clean energy, sustainable agriculture, or diversity)
• Shareholder advocacy and engagement (using shareholder power to influence corporate behavior)
• Impact investing (targeting measurable positive social or environmental impacts from investments)

These approaches represent a mosaic of options allowing investors to tailor and target portfolios to reflect their financial needs and values around issues like climate change, human rights, and corporate governance.

Targeting Themes and Impact

Responsible investment options exist covering a vast universe of funds across geographies, asset classes, and investment styles. But some funds home in on specific ESG themes or impacts.

Examples include:

• Clean energy funds investing in renewable companies to support the transition from fossil fuels
• Affordable housing funds financing homes for underserved communities to increase access
• Diversity funds targeting greater gender representation in portfolio company leadership
• Microfinance institutions providing loans to disadvantaged entrepreneurs internationally
• Green bond funds financing large-scale sustainability initiatives from companies and governments
• Healthcare access funds expanding hospitals, clinics, and medical equipment in emerging economies

From clean water financing to sustainable forestry support, targeted responsible investing options allow tailoring portfolios to issues investors care about – and measuring impact.

Shareholder Advocacy

Investors have another tool to influence responsible business practices: shareholder power. Shareholders advocate through:

• Proxy voting for shareholder resolutions requesting sustainability reporting or other ESG actions from company management
• Filing shareholder resolutions directly addressing concerns like climate lobbying or human rights risk management
• Engaging directly with company leaders to request improved ESG disclosure or performance

Large asset managers and pension funds like BlackRock and CalPERS have teams conducting this advocacy and engagement work – either directly or by joining investor coalitions.

Research from US SIF shows 365 shareholder resolutions related to ESG issues were filed by US institutional investors in 2019. Shareholder advocacy leverages investments to steer companies toward more sustainable and ethical practices aligned with investor priorities.

Challenges of Responsible Investing

Despite significant growth, barriers to broader adoption of responsible investing remain. Common critiques include:

• Limited options. While expanding, fewer responsible investment products exist compared to conventional funds – especially in niche categories like small-cap stocks.
• Potentially higher fees. Specialized ESG research and shareholder engagement work can contribute to marginally higher expense ratios for some responsible funds compared to traditional ones tracking mainstream indexes.
• Subjective choices. Social and environmental standards are often more subjective compared to financial analysis. Different investors make vastly divergent choices on issues like animal testing, weapons involvement, or Israel/Palestine politics.
• “Greenwashing” fears. Limited transparency into ESG vetting processes at some funds leads to concerns about companies or products not matching responsible branding. Pressure grows for stricter standards.
• Performance uncertainty. While many studies show a positive or neutral impact, some investors remain unconvinced incorporating ESG factors helps portfolio results rather than introducing unwanted risk or constraints.

While options have expanded across geographies, asset classes, and financial styles, responsible investing still commands just over one-third of total US assets under professional management based on US SIF data. Work remains to address investor doubts on issues like long-term viability and return trade-offs relative to other active or passive products. However, the responsible investing industry continues working to polish options and dispel lingering misconceptions.

Getting Started

Interested in aligning your money with your values? Here’s how to put responsible investing concepts into practice:

Learn your priorities

Commit time upfront to identify your top ESG concerns. Are clean energy access, affordable housing, or diversity and inclusion top of mind? Defining personal priorities is crucial for identifying aligned investment options.

Ask your financial advisor

Share ESG priorities with your wealth manager, financial advisor or 401k administrator. Many leading financial institutions now incorporate responsible investing options and resources. Ask what options exist to construct portfolios reflecting your sustainability priorities alongside financial security.

Research options

Responsible mutual funds and ETFs exist spanning geography, asset class, and investment style. iShares ESG Aware (MSCI) or Calvert Funds represent solid responsible index fund options to start. Review funds marketing screened portfolios, shareholder advocacy, or measurable social/environmental impacts in line with your priorities.

Compare offerings

Evaluate investment products on criteria like screens and exclusions, ESG integration techniques, shareholder activism policies, transparency, and performance history. Review the prospectus language for specific details. Leading investment research firms like Morningstar now provide dedicated responsible investment fund evaluations including peer group comparisons across these metrics.

Start small

Experiment by carving out a portion of your portfolio for initial allocation to responsible investment funds or products. Monitor and compare performance over 6-12 months. Incrementally increase allocations as conviction grows.

From negative screening funds to shareholder advocacy to private impact investing in areas like community financing, options exist to align portfolios with your financial and social values. Follow the tips above to get started. Your money can increasingly support both personal priorities and financial growth through responsible investing.

Conclusion

Responsible investing has moved fully into the mainstream – with investors recognizing money should reflect more than just numbers. It should also mirror deeply held social and environmental values.

From climate change to equality to ethical corporate leadership, responsible investing strategies help target portfolios to the issues investors care about – without sacrificing financial returns.

As the trends make clear, how we invest is just as important as what we invest in. Follow the guidelines here to get started investing responsibly and get ahead of the future. Your wallet and the world will thank you.

The future depends on it.

Responsible Investing FAQs

Have more questions? Below are answers to several frequently asked questions about responsible investing:

What is the difference between ESG investing and socially responsible investing (SRI)?

These terms are often used interchangeably. Some investors stick with SRI to mean values-based screening out of industries like weapons or tobacco. ESG has emerged as the more commonly used mainstream term reflecting the assessment of environmental, social, and governance factors material to financial performance.

Does responsible investing involve sacrifices or negative performance trade-offs?

Increasingly no – hundreds of financial studies, including metareviews, show no systematic financial penalty associated with responsible investing. Performance is comparable to conventional funds. Management fees can be marginally higher due to extra research and shareholder engagement costs.

What ESG issues are most material for financial performance?

While wide-ranging, “E” topics like emissions and resource management are often most tied to near-term profitability through shifting regulations, physical climate impacts, and reputational factors. “S’ factors like labor relations also carry immediate financial implications.

How can performance differences among responsible investment funds and products be benchmarked?

Investment research firms like Morningstar provide category-specific responsible investment designations and metrics allowing performance evaluation relative to category peers – much like conventional fund analysis. Metrics like designated peer percentile rankings help investors compare options.

Can responsible investment options exist inside employer-sponsored 401k plans?

Increasingly yes. Leading 401k providers like Vanguard, TIAA, and Fidelity now provide a range of ESG-designated options spanning major asset classes and styles. Additionally, self-directed brokerage windows within many 401k plans allow access to other responsible mutual funds or ETFs.

Does responsibly invested money mean accepting lower returns?

Based on decades of industry data and third-party analysis, responsible portfolios do not show systematic underperformance compared to conventional ones. Integrating ESG factors helps identify future risks and opportunities – theoretically contributing to risk-adjusted outperformance over longer time horizons.

Responsible investing helps align your money with your values – without sacrificing financial returns.