4 Things to Keep in Mind About Sustainable Investing in 2022
And four ways that it's having a broader impact on the world.
Sustainable investing had another successful year of growth, performance, and influence in 2021. Global sustainable funds attracted record inflows in just the first three quarters of the year, while their overall assets under management approached $4 trillion. Performance remained strong. Based on year-to-date returns as of mid-December, 56% of sustainable funds ranked in the top half of their respective Morningstar Categories, and only 44% ranked in the bottom half. Sustainability concerns, particularly around the climate crisis, are on the agendas of regulators around the world and have gained influence in Washington with the new administration.
If you are one of the many individual investors or financial advisors considering adding a sustainability lens to your investments in 2022, here are four things to keep in mind about sustainable investing:
Sustainable investing is not a singular approach but instead represents a range of methods that investors can use to generate competitive investment returns while helping generate positive outcomes for people and planet. Our Sustainable-Investing Framework describes six distinct approaches to investing with sustainability in mind. Any given sustainable fund may use one or a combination of these approaches. In addition, these approaches are used in conjunction with standard investment practices that emphasize things like style, quality, or momentum.
What does this mean for you? It's important to take the time to understand what's under the hood. Do not assume that funds with names that include terms like "Sustainable" and "ESG" are identical investments. A good example is the treatment of fossil fuel exposure in sustainable funds. Some funds avoid such exposure altogether. Others have "best-in-class" environmental, social, and governance standards for fossil fuel companies to make it into their portfolios. Many of the funds that do include fossil fuel companies have ramped up their engagement with those companies to press them to reduce emissions. Some fixed-income funds may purchase green bonds issued by fossil fuel companies to help them finance renewable energy projects. And funds focused on renewable energy may have a lot of exposure to fossil fuel companies that are making major investments in renewables.
So, it's important to look under the hood to understand the details of any sustainable fund you are considering, particularly now that there are more than 500 open-end and exchanged-traded sustainable funds available to U.S. investors. A lot of the claims of "greenwashing" really have to do with a mismatch between investor expectations and a fund's specific sustainable-investing approach. Funds can do a better job of informing investors about exactly which approach or approaches to sustainable investing they employ. Because of the urgency of the climate crisis, all sustainable funds should publish a Statement on Climate Change indicating how they are addressing climate-related issues.
Sustainable investing is connected to bigger-picture global changes. We are moving from an era in which most investors were OK with public companies making money for them while also generating negative social or environmental consequences, to one in which investors increasingly expect companies to make money while avoiding such costs or generating positive impacts. Rather than focusing solely on how ESG risks may affect an investment, more sustainable investments are also assessing the impact of an investment on people and planet. Innovations include funds focusing on improving corporate behavior through deep engagement and proxy voting, and funds starting to apply net-zero criteria to their investment selections.
Sustainable investments should be expected to generate competitive long-term performance. Sustainable investors should neither expect to always outperform nor to always underperform, but they should expect investment returns that are competitive with those of conventional investments. It has been hard to bust the myth that sustainable investments underperform. That certainly hasn't been the case during the past few years when, on the whole, sustainable funds have performed better than conventional funds. Keep in mind that returns of sustainable funds are not determined solely by the use of sustainability criteria, but also by other investment criteria employed by fund managers, so it's hard to sort out the relative effects of each on performance. That's why I recommend evaluating a sustainable fund's overall performance holistically and compare it with that of all funds that invest from the same broad asset class or investment category.
Sustainable investing is primarily about investing, not social or environmental activism, but it does have impact on the world. You may be attracted to sustainable investing because of your own social or environmental concerns, but the main focus of a sustainable fund is to generate competitive investment returns to help you reach your financial goals. That said, by making a sustainable investment, you are having more impact with your money than if you invested in a conventional way.
Here are four ways that sustainable investments are helping to generate impactful outcomes for people and planet:
Having reasonable expectations for any type of investment is important for investor success. For sustainable investing, keep in mind that it includes a range of still-evolving approaches, so it's important to look under the hood of any sustainable fund to make sure it aligns with your expectations. Keep in mind, too, that sustainable investments are primarily performance-driven and should be held to the same reasonable performance standards you expect from any investment. And while impact may be secondary to performance, sustainable investments are achieving broader impact in several ways. I expect to see more innovation on the impact dimension in 2022.
Jon Hale does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.