Sustainable investing has grown in recent years, led by younger investors. Many Millennials and Gen Z want their portfolios to serve dual purposes like generating positive returns while also supporting environmental sustainability* and socially-responsible causes.

(*Environmental sustainability happens when we interact with the environment without hurting or destroying its natural resources.)

You can build a portfolio with sustainable investments — also known as ESG— while still gaining solid returns. But first, it’s important to know the basics of what makes an investment sustainable and how ESG factors are incorporated.

What is ESG?

ESG refers to the environmental, social, and governance practices of a company.

ESG integration refers to the inclusion of these three factors in investment decisions.

Integrating financial and non-financial (ESG) factors into the investment process can help manage sustainability risks in your investment portfolio.

Traditional investments value companies based on their profitability. Funds which integrate or include ESG factors into their investment process, on the other hand, also value companies on items such as:

  • how well they manage their carbon footprint,
  • social effects such as labour laws and gender equality, and
  • the quality of leadership in the businesses, among other considerations.

Can sustainable funds outperform traditional investments?

Research shows that embedding ESG factors into investment decision-making can have a positive effect on investment returns.

For example, according to investment research firm Morningstar, funds that included ESG factors in their investment approach did take a sudden loss earlier this year due to the COVID-19 pandemic. But they held up much better than funds that didn’t include sustainability factors. Morningstar’s research also states that 24 out of 26 environmental, social and governance-titled index funds outperformed their conventional counterparts.

What issues define ESG?

Environmental factors look at how the company responds to issues like:

  • climate change,
  • air pollution,
  • biodiversity,
  • water resources and pollution,
  • energy resources and management.
     

Social factors include a company’s response to issues like:

  • human rights,
  • political freedoms,
  • treatment of employees’ health and safety,
  • crime and safety,
  • trust in society and institutions, and
  • social exclusion and poverty or wage disparity.

Governance* refers to how the company operates, which includes factors such as:

  • audit practices,
  • shareholder rights,
  • tax practices,
  • accounting standards,
  • dual-class share structures, and
  • institutional strength.

 (*Governance also refers to whether or not a company aligns their compensation packages with results and performance. It also notes if a company’s leadership team is communicating clearly, effectively and transparently with all internal and external shareholders.)

Of course, a company’s overall balance sheets and profitability are also evaluated within ESG investments.

Larger companies may be benchmarked against the UN’s sustainability goals. Stock exchanges have their own guidelines, such as the Toronto Stock Exchange’s “A Primer for Environmental & Social Disclosure.”

  • Did you know Sun Life is considered one of the most sustainable corporations in the world? Find out more.

ESG vs. SRI investments: What’s the difference?

As you research ESG investments, you may see another term: SRI investments.

SRI stands for Socially Responsible Investing. It’s one approach to investing sustainably.

SRI funds select or eliminate investments based on ethical guidelines due to personal, political or religious beliefs.

SRI investing relies on ESG factors to positively or negatively screen investments. This usually removes investments such as tobacco, alcohol, fossil fuels or firearms. Other aspects that may get screened out include:

  • weapons and defense industries,
  • gambling and other potentially addictive actions and substances,
  • human rights violations, and
  • investments that may have ties to terrorist groups.

Funds which include or integrate ESG into their process consider these factors as well. But their main objective remains the financial performance of the funds.

With SRI investments, however, there’s usually an underlying motive that affects the investor’s decision to choose funds for their portfolio.

Having funds with ESG factors in your portfolio

For those with sustainability mindset, who also want a diversified portfolio, investments which consider ESG factors may be a good option. Even during the pandemic, these investments remained strong due to increased social and environmental awareness.

It’s also important to note that many funds integrate ESG factors already – without having any particular labels attached.

If you want to learn more about how ESG works, contact your advisor. An advisor can help you make sure you’re investing sustainably. They can also help you figure out which investments can meet your short- and long-term goals.

 

This article is meant to only provide general information. Sun Life Assurance Company of Canada does not provide legal, accounting, taxation, or other professional advice. Please seek advice from a qualified professional, including a thorough examination of your specific legal, accounting and tax situation.