When it gets right down to it, investing is about making money. But you don’t have to place your money with companies or industry sectors that aren’t aligned with your moral compass. And you can choose to invest in companies that behave well and that set the example for others as good corporate citizens.
Welcome to the world of values-based investing—also called sustainable investing, socially responsible investing, and impact investing—where you can shape your portfolio to reflect your moral values and personal beliefs.
But before we begin our deep dive into this strategy, let’s address one of the biggest misconceptions about this investing approach.
Misconception: Values-based investors sacrifice investment performance
Some detractors claim that values-based investing will result in inferior investment performance because they believe these portfolios are less broadly diversified than those that don’t exclude corporate pariahs.
But it’s important to remember that all thoughtful investing involves building a selected portfolio of holdings based on criteria designed to increase an investor’s chances of success. Traditional financial analysis identifies a universe of viable investment opportunities. Values-based investors can take the process a step further by applying a set of additional parameters to narrow this universe down to a targeted list of companies that they believe don’t have a negative impact on the environment and/or society as a whole.
And contrary to what the skeptics say, this approach may actually enhance returns, since there is a growing body of research that indicates that companies that behave well deliver better investment performance relative to similar companies with less-than-stellar corporate reputations.
While the specific methodologies researchers use to “rate” companies vary, there’s a growing consensus that emphasizes three categories:
- Environmental factors: Is the company committed to maximizing energy efficiency, reducing waste and pollution, preserving natural resources and minimizing its carbon footprint?
- Social factors: Does the company pay fair wages and provide affordable healthcare and other quality of life benefits to employees? Is it committed to building a diverse workforce with equal opportunities for women, minorities, and LGBTQ employees? Is management committed to workplace safety? Does it strive to deliver customer satisfaction? Is the company involved in philanthropy and community outreach in its various locations?
- Governance factors: Is executive compensation reasonable? Are board members independent and free of conflicts of interest? Does the corporation have sound anti-corruption and whistleblower protection policies in place? Does it fully disclose lobbying activities and political campaign and PAC contributions?
Not surprisingly, these categorizations have spawned marketable terms such as “ESG factor investing” and “sustainable investing” which are now being incorporated into values-based indexes, independent researcher ratings, and new families of values-based mutual funds and exchange traded funds (ETFs).
Implementing your own values-based strategy
Whether you want to fully embrace values-based investing or just “dip your toes,” there are a number of ways to do it. Although some investors still use a “sin sector” approach to automatically exclude businesses such as tobacco companies and gun manufacturers, the modern approach to values-based investing focuses on seeking companies with strong ESG credentials. So let’s focus on several ways you can do that.
Investing in individual securities
This approach gives you total control over which companies you wish to invest in. The challenge: the time and effort it takes to research and evaluate a company’s ESG values. Fortunately, companies such as MSCI (in its MSCI ESG ratings) give thousands of companies an overall ESG score as well as separate ratings for the three factors.
The main drawback is that many of these ratings are only available to investment professionals and institutions that pay for them, although some brokerage companies incorporate them into their research platforms. Another issue: as with any portfolio, it may be difficult to build a portfolio that offers enough exposure to a broad range of investment categories, which may reduce the opportunity to diversify.
These mutual funds and ETFs use proprietary or third-party research to build a universe of companies with strong ESG characteristics. They may either start with a broad universe of viable investment candidates identified through traditional research methodologies and then apply the ESG filters to narrow down the list or begin with a list of companies with strong ESG credentials and then analyze them individually to identify good opportunities.
While most ESG funds fall into traditional size- and style-based categories (large cap, small cap, growth, value, etc.), a number of specialized ESG funds focus on particular themes, such as companies with strong representation of women in senior positions or those in the green energy business.
A compromise approach—hybrid investing
If you’re not quite ready to fully embrace the idea of values-based investing, you may want to “test the waters” by adopting a hybrid strategy. You can do this by taking some money from your broadly diversified portfolio and investing in companies or ESG funds that meet your values-based criteria.
Another approach is to own mutual funds with significant holdings in companies with strong ESG characteristics. Morningstar’s Sustainability Ratings™ for Funds can help. More than 20,000 funds are rated against their Morningstar category peers on how well the companies in their portfolios are managing their ESG risks and opportunities. While this information can be helpful, it’s important to remember that the rating doesn’t necessarily reflect indicate a fund’s commitment to sustainable investing; a company’s ESG credentials may have little or nothing to with the fund manager’s decision to buy or sell shares.
Even if you’d prefer not to adopt a values-based investment strategy, you can still encourage companies to demonstrate good behavior by exercising your rights as a shareholder. Many investors team up to voice their views at shareholder meetings, and initiate proxy votes to encourage companies to adopt more responsible policies and practices. Others pressure pension funds and endowments to divest of companies until they’ve “cleaned up their corporate act.”
Does values-based investing make sense for you?
As we’ve seen, there are ways you can encourage companies to become better corporate citizens without necessarily banning them from your portfolio. And you don’t have to transform your entire portfolio to get the satisfaction of investing more in some companies that reflect your values. In the end, however, such decisions also need to reflect your own personal situation and investment goals.
If you’d like to discuss the potential benefits and risks of values-based investing in greater detail, feel to contact me or any advisor at Canby Financial Advisors.
Christopher Gullotti is a financial advisor located at Canby Financial Advisors, 161 Worcester Road, Framingham, MA 01701. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at firstname.lastname@example.org.
Investments are subject to risk, including the loss of principal. An investment's socially responsible focus may subject it to social criteria risk, which involves the exclusion of certain securities for nonfinancial reasons. This may result in the investor forgoing some market opportunities that may have been available to those not subject to these criteria. There is no guarantee that any investment goal will be met.
©2018 Canby Financial Advisors
 Bank of America Merrill Lynch, ESG Part 2: A Deeper Dive, https://www.bofaml.com/content/dam/boamlimages/documents/articles/ID17_0028/equityStrategyFocusPointADeeperDive.pdf?pwm=6000; Amirslani, Lins, Servaes, A Matter of Trust? The Bond Market Benefits of Corporate Social Capital During the Financial Crisis, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3042634