Investing based on your principles

Are you interested in investing based on your personal principles? If so, you might want to consider sustainable investing. Integrating sustainable investing components—environmental, social, and governance (ESG)—into your research might enhance your ability to align your investments with your principles.

It has become easier than ever to accomplish this goal. The growth in sustainable investing vehicles has been substantial, providing an increasing number of opportunities to potentially find investments that match your investing goals.

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. Fidelity defines sustainable investing as an investing approach that integrates ESG factors into research and decision-making. Evaluating ESG factors that are material to a given industry and company can help assess an investment’s sustainability.

Generally, sustainable investing can mean selecting companies that limit the negative impact their operations and products have on the environment; focus on more equitable relationships among and between their customers, employees, suppliers, and communities they operate in; and exhibit accountable and transparent governance with diverse and independent boards; offer compensation incentives that align with shareholders; and sound capital allocation policies.

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. Those factors are:

• 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. Examining environmental factors can reveal which companies are responsive to consumer demand for sustainable practices. There are many examples of these types of investments.
• 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. A focus on social themes can identify businesses that demonstrate a commitment to a diverse and inclusive workplace. 
• 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. Attention to governance can uncover which companies are committed to diverse board composition and shareholder-friendly policies.

Something to consider when evaluating opportunities based on ESG criteria is what characteristics actually qualify this type of investment. Simply because a company states their goal is to reduce carbon emissions, for example, does not mean the company will definitely follow through with reducing their carbon footprint.

Aligning your principles and objectives

The primary reason to consider an ESG investing strategy is an attempt to match your personal beliefs with your investments.

Also, 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.

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. As with any investment, costs (and performance) should always be an important consideration.

Looking deeper into ESG

An important 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 US market as well as other developed markets. 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. Not only has the classification evolved over time, it is defined and evaluated in varying ways by different companies.

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 and 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

You can search for sustainable investments on Fidelity.com using our stock, ETF, and mutual fund screeners, based on environmental, social, and governance characteristics.¹ 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.

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:²

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.

To find ESG ETFs, go to the ETF/ETP Screener, select "Start a screen" (login required) 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 mutual fund or ETF. Even if you are knowledgeable, a mutual fund or ETF may be a good way to gain diversified 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.