Investing based on your principles

Thinking about investing using environmental, social, and governance factors?

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Are you interested in investing based on your personal principles? If so, you might want to consider sustainable investing.

In the past, some investors have avoided sustainable investing strategies for fear of sacrificing performance. Yet numerous studies have not concluded that incorporating sustainable investing factors results in a negative impact on performance. Additionally, the growth in sustainable investing vehicles has been substantial, providing investors with an increasing number of opportunities to potentially find investments that align with their goals. The Global Sustainable Investment Alliance estimates there has been a 34% increase over the past 2 years in global sustainable investing assets under management, reaching $30.7 trillion. Growth has been particularly strong in Japan, as well as in the US, where sustainable investing assets have soared 38% since 2016 to nearly $12 trillion (see Sustainable investing growth in the United States).


Here is a closer look at what sustainable investing entails, along with a few opportunities to consider.

What is sustainable investing?

Sustainable investing is known by many names. Among them: socially responsible, ethical, impact, and principles-based investing.

According to MSCI, this investing approach looks at a company's environmental, social, and corporate governance (ESG) practices as well as its overall investment decision-making process. While such an investing approach isn't new, its definition and objectives have evolved over the years—from avoiding certain investments (so-called "sin stocks," such as tobacco, firearms, alcohol, and casinos) to a more holistic approach, based on ESG factors, which include:

  • Environmental impact—An environmentally friendly investing objective can include companies that produce renewable and sustainable energy, enhance energy efficiency, source raw materials using eco-safe methods, use little or no hazardous chemicals in their production process, limit waste, and prioritize recycling. There are many examples of these types of investments. For example, some of the largest clean-energy ETFs, by net asset value, are the iShares Global Clean Energy ETF (ICLN), Invesco Wilderhill Clean Energy (PBW), and First Trust Nasdaq Clean Edge Green Energy Index Fund (QCLN).1 Some of the largest clean-energy mutual funds by net asset value are Pax Global Environmental Markets Fund (PGRNX), Green Century Balanced Fund (GCBLX), and New Alternatives Fund (NAEFX).1
  • Social issues—Positive social investing objectives focus on companies that consider the impact upon all stakeholders, such as seeking gender equality, providing healthy working conditions and lifestyles, addressing wealth inequality, and showing a commitment to charitable endeavors, among other factors. The largest fund by net assets that focuses on gender diversity is the SPDR SSGA Gender Diversity Index ETF (SHE).1
  • Governance quality—Strong corporate governance systems entail having policies and principles that address potential conflicts of interest among stakeholders (e.g., managers implementing policies that benefit themselves, rather than shareholders), and including an independent board and audit committee that seek to protect shareholders over management.
 

Something to consider when evaluating opportunities based on ESG criteria is what characteristics actually qualify something for this type of investment. Simply because a company states their goal is to reduce carbon emissions, for example, that does not mean that align with ESG goals (or that the company will actually follow through with reducing their carbon footprint). You can search for sustainable investments on Fidelity.com using our stock, ETF, and mutual fund screeners, based on environmental, social, and governance characteristics. When considering these types of investments, you may want to evaluate their potential impact on your portfolio's diversification, due to the application of ESG filtering criteria and the narrowness of certain ESG fund mandates.

The growth of sustainable investing

Sustainable investment opportunities have grown dramatically in recent years. A September 2019 Morningstar analysis found that a record number of funds launched in 2018, with last year being the third consecutive year of net inflows. Average annual net flows from 2013-2018 were 30 times greater than from 2009-2012. There are now sustainable funds in 65 Morningstar categories.

This growth is driven by a variety of factors, including increasing recognition that ESG issues are financially material, concerns about the impact of companies focusing too much on short-term performance at the expense of long-term goals, and the desire to align company objectives with values of investors, clients, and beneficiaries. 

Perhaps not surprisingly, demand for sustainable investment opportunities also appears to be particularly high among younger investors. More than 8 in 10 millennials said they were interested in sustainable investing, according to another survey by Morgan Stanley.2 Given that millennials are expected to have $19 trillion to $24 trillion in assets by 2020, sustainable investing may have some wind at its back.3

The case for ESG investing

Aligning your principles with your investments
One of the primary reasons to consider an ESG investing strategy is an attempt to match your personal beliefs with your investments. Moreover, a company that focuses on ESG factors can signal operational efficiency and lower costs, reduced environmental liability, opportunities for low-carbon revenue sources, effective management of human capital, reduced risks related to product/service safety, opportunities for an expanded customer base, financial and operational decisions that best serve shareholders, reduced risk from reputational damage or weak financial controls, and well-managed operations and costs in the face of regulatory changes.

Performance vs. peers
Some recent research shows there is no systematic performance penalty associated with sustainable investing or ESG funds. Morningstar's 2019 sustainable investing report found that 63% of sustainable funds finished 2018 in the top half of their respective categories (including 35% in the top quartile), helping lift 58% of funds into the top half over the trailing 5 years. Of note, sustainable equity funds outperformed conventional peers in negative market conditions.

On-par expenses
As with any investment, costs should always be an important consideration. Expense ratios for ESG funds have been found to be similar to those for traditional mutual funds within similar categories (see graphic below).

Of course, there is variability in average costs within categories as well as the range of averages across categories (as well as variability in return, both within and across categories), as measured by expense ratios, highlighting why it’s important to evaluate each investment opportunity on its own merit and, perhaps more importantly, to determine whether an investment is right for you. Always be sure to consider your investment objectives, risk constraints, time horizon, liquidity needs, and tax situation.

Another caveat when assessing these types of investments is that there is not as much historical performance data for ESG funds compared with, say, the broad market. For this reason, the research and conclusions drawn from sustainable investing may not be as profound. Additionally, the classification of a sustainable investment strategy has shifted over time (think “sin stocks” versus ESG factors), making measurement and comparisons somewhat complicated.

Moreover, just because an investment is defined as ESG, that doesn’t mean it meets your definition or requirements. If you are looking for a particular type of sustainable investing strategy, you may need to search for investments that match the factors that are important to you. For example, if you are primarily interested in green energy investments, and would like to invest in an ETF or mutual fund, consider the objectives of the fund as well as evaluate the holdings of the fund to see if the components actually meet your definition of an ESG investment. You may also want to assess the fund relative to an alternative energy benchmark index. Some of the most popular benchmarks in this space are the S&P Global Clean Energy Index (SPGTCLEN), NASDAQ Clean Edge Green Energy Index (CELS), or World Alternative Energy Index (WAEXPDC).

How to find sustainable investing ideas

A large and growing number of mutual funds and ETFs with a socially responsible investing mandate are now available—in addition to individual stocks of companies that would qualify as an ESG investing candidate. For example, some of the largest socially responsible ETFs and mutual funds by net assets are:

ETFs Mutual funds
iShares MSCI KLD 400 Social Index Fund ETF (DSI) Parnassus Core Equity Fund (PRBLX)
iShares MSCI USA ESG Select ETF (SUSA) Parnassus Endeavor Fund (PARWX)
iShares MSCI ACWI Low Carbon Target (CRBN) Vanguard FTSE Social Index Fund (VFTSX)
Invesco Solar ETF (TAN) TIAA-CREF Social Choice Fund (TICRX)
SPDR SSGA Gender Diversity Index ETF (SHE) Ariel Fund Equity Fund (ARGFX)
Source: ETF.com, Morningstar, as of September 23, 2019. The mutual fund list excludes American Funds Washington Mutual, which does not meet Fidelity’s definition of socially conscious investment strategies.
 

Fidelity's ESG index funds now include Fidelity US Sustainability Index Fund (FITLX), Fidelity International Sustainability Index Fund (FNIDX), Fidelity Sustainability Bond Index Fund (FNASX), Fidelity Select Environment & Alternative Energy Portfolio (FSLEX), and the recently launched Fidelity Women's Leadership Fund (FWOMX). The latter is an actively managed, US equity fund that invests primarily in companies that prioritize and advance women’s leadership.5 You can see the holdings of each of these funds by going to the fund snapshot page and selecting "View holdings" to help assess whether the investments match your sustainable investing criteria. This might be accomplished by further researching each individual fund holding to help determine if they match your sustainable investing objectives.

If you want to find these types of investments on your own, you can do so on Fidelity.com via the stock, ETF, and mutual fund screeners. For example, to find ESG ETFs, go to the ETF/ETP Screener, select "Start a screen" and choose "Socially Responsible" to search by the 3 ESG criteria. After you run a screen, your next step should be to determine if it aligns with your objectives and risk tolerance.

If you are interested in ESG investing, but aren't sure how to get started, you may want to consider a professionally managed mutual fund. Even if you are knowledgeable, a professionally managed solution—be it a mutual fund or ETF—is generally a good way to gain ESG exposure, given the research intensity and inherent risks of ESG investing. Either way, with a plethora of choices, it’s increasingly possible for you to invest based on your principles.

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