As more investors look to add sustainable investments to their portfolios, it’s important to understand exactly what that means. Learn how investing for sustainability impact works, whether it pays off financially, and how you can get started.
Definition and Example of Investing for Sustainability Impact
Investing for sustainability impact refers to an investment strategy and mindset that seeks dual goals: impact and financial return. These investors seek to achieve financial returns by investing in only businesses focused on the sustainability mission, promoting sustainability goals and positive change. When investing for sustainability impact, investors are being intentional about using their money to influence or support the behavior of company management and boards to promote positive change in our economic systems for the good of the environment and society. You may see it as an economic and financial vote.
Acronym: IFSI
Later in this article, we’ll break down the differences between investing for sustainability impact and other impact investing practices. Sustainable investing practices have quickly become mainstream, but as investing for sustainability impact is a more specific investment approach, there are fewer examples of it in practice. That being said, a growing portion of assets are invested for sustainability impact, at least to some extent. One example of investing for sustainability impact in practice is the Net Zero Asset Managers initiative an international group of asset managers working to invest with the goal of reducing greenhouse gas emissions. It was launched in December 2020 and has over $57 trillion in assets under management. Another example is the Net Zero Asset Owners Alliance, which is a U.N. convened group of institutional investors seeking to transition their investment portions to net-zero greenhouse gas emissions with more than $10 trillion in assets under management, respectively. Both of these groups strive for investor action and portfolios that will help limit global warming to 1.5 degrees Celsius in line with the Paris Agreement.
How Does Investing for Sustainability Impact Work?
The goal of investing for sustainability impact is to intentionally allocate your money in a way that influences the behavior of companies and policymakers to reach sustainability impact goals. Often, these goals are focused on either reducing a negative impact or creating a positive impact (or both). Examples can include funding specific sustainability projects or the net-zero emissions goal of the Net Zero Asset Managers Initiative. Additionally, investing for sustainability impact emphasizes creating assessable or measurable impact. That makes this approach more comprehensive than other types of impact or sustainable investing.
Types of Investing for Sustainability Impact
Investing for sustainability impact can be broken down into two different categories: instrumental IFSI and ultimate-ends IFSI. The difference between the two comes down to the relationship between the sustainability impact goal and the financial returns.
Instrumental IFSI
This is an investment approach where achieving the sustainability impact goal is instrumental for your financial return. An example could be investing in a particular sustainability project. If the project succeeds, you achieve your targeted return.
Ultimate-Ends IFSI
This is an investment approach where the sustainability impact goal is overarching and is not connected to the financial return goal. While both goals are pursued, your financial return isn’t dependent on the success of the sustainability impact goal.
Investing for Sustainability Impact vs. Other Sustainable Investing Approaches
It’s important to discuss the differences between investing for sustainability impact and other types of sustainable investing, including impact investing, ESG investing, and socially responsible investing (SRI). Another big difference is that investing for sustainability impact puts a clear focus on assessment and measuring the impact. So far, there has been little uniformity and clarity in measuring the impacts of ESG or other sustainable investing outcomes. Sustainable investing can generally take two different forms. First, you can take an exclusionary approach, where you avoid investing in companies or funds that are at odds with your values. For example, you may choose to avoid investing in industries that can be harmful to the environment, such as oil or coal. Others may avoid investing in what are known as “sin” stocks, which include companies in industries that can be harmful to society, such as weapons, gambling, or tobacco. You can also take an intentional approach where, rather than simply avoiding companies that are at odds with your values, you actively seek to invest in companies that promote positive environmental or societal change. If you take this approach, you would seek out companies with certain positive ESG characteristics. ESG factors that you and investment managers might look for are outlined below. For example, you may seek out companies that promote animal welfare, have pledged to reduce child poverty, or have allocated a percentage of their profits to environmental issues. These are just a few examples—this type of impact investing can take many different forms.
Is Investing for Sustainability Impact Worth It?
Investing for sustainability impact allows you to allocate your money toward companies that promote positive environmental and social change. But that’s not the only goal of this investment strategy. It’s still important for investors to achieve a positive financial return. So that begs the question, is investing for sustainability impact worth it? Based on investor feedback and financial performance of other sustainable and impact investing approaches, the answer is yes. First, a survey from the Global Impact Investing Network found that the vast majority of respondents said both impact and financial returns from their investments were in line with their expectations. A smaller percentage reported returns that outperformed their expectations, and the smallest percentage reported returns that underperformed their expectations. We can also look at studies that have looked at the trends of sustainable investments compared to traditional investments. One study by Morgan Stanley’s Institute for Sustainable Investing looked at the returns of nearly 11,000 mutual funds between 2004 and 2018. It found that there was no financial trade-off for investing in sustainable funds rather than traditional funds, and that sustainable funds have lower downside risk. And according to data from financial services company Morningstar, a majority of sustainable funds (69%) in 2020 ranked in the top half of their category for trailing five-year performance. So such funds proved to be attractive investments if you invested even as far back as 2015. Sustainable investing has seen a considerable shift in the past couple of years. For one, there has been a significant increase in impact investing since 2020. According to US SIF, a nonprofit working in the area of sustainable investing, at the start of 2020, roughly $1 in $3 invested dollars were in a sustainable investment strategy. Other data from Morningstar showed net inflows (total money flowing into minus money flowing out) into sustainable funds in 2020 stood at $51.1 billion, more than double compared to $21.4 billion in 2019 and approximately 10 times the nearly $5 billion in 2018.
What It Means for Individual Investors
Several studies have shown that you can build an investment portfolio of sustainable investments without significantly harming your financial returns. These studies are good news if you want to fund your financial goals while also supporting companies that align with your values. But how do you actually get started in investing for sustainability impact? There are plenty of options when it comes to other forms of impact investing. It’s easy to visit a robo-advisor or brokerage firm and find funds and investment options for ESG investing or socially responsible investing. But you aren’t likely to come across any funds specifically designated as investing for sustainability impact. One option is to find an organization like the Net Zero Asset Managers Initiative and work with an asset manager who is committed to a cause designed to create positive environmental or social change.
