5 ways for Canadian investors to invest sustainably

Sustainable investing means different things to different people. For some it is about avoiding certain activities or industries. Others see it as a more proactive approach - making a positive difference. Not just ‘do no evil’ but be a force for change.

A helpful way to think about the range of approaches is as a spectrum that runs from value-driven traditional investors all the way through to values-driven philanthropists.

On one end of the spectrum, the traditional investors generally have limited or no focus on environmental, social and governance (ESG) factors of underlying investments as they’re primarily interested in generating competitive returns

At the other end of the spectrum is philanthropy. Philanthropists are those that give little to no consideration to competitive returns as they’re mainly focused on making a positive impact and solving one or multiple environmental and social issues.

There’s no “one size fits all” when it comes to sustainable investments - sustainable investment strategies will typically use one or more of the following. 

1. Screening

Screening is a process for determining which investments are or are not permitted in a portfolio. Generally, rules are applied to determine whether an investment is permissible. Within screening, there are different ways to do so.

Negative or exclusionary screening

This is traditional “ethical” investing. It is about avoiding or excluding certain types of securities or companies based on certain ESG-related activities, business practices, or business segments that may be considered controversial– things like weapons manufacturing and trading, tobacco sales, adult entertainment, the extraction of fossil fuels. Where you draw the line on this list is a matter of personal values.

There’s also a risk management dimension to negative screening strategies. For example, changing values or regulatory shifts may mean a few things: that the oil and gas business is in long-term decline, its cost of capital may rise over time, and/or many of the reserves booked by energy companies may never be exploited. These are all real financial risks that can potentially be avoided by using an exclusionary approach. Ultimately, exclusion is most often a moral question.

Positive or best-in-class screening

This is the opposite of exclusion. Best-in-class screening involves looking for companies that perform better than their peers on one or more performance metrics related to ESG. A favourable ESG score is a form of proxy for quality. Companies that understand the forces shaping the world around them and respond appropriately are, by definition, better companies. In turn, investors may reward these companies with higher valuations and lower cost of capital.

Norms-based screening

This involves applying rules based on compliance with widely recognized ESG-related standards or norms, such as UN Global Compact, International Labour Organizations Standards, among others. Lack of compliance would lead to an investment not being permitted, and compliance would lead to an investment being permitted in the portfolio. 

2. ESG integration

When investment professionals say that sustainability is a core part of their investment process, what they are really saying is that their research considers ESG-related factors that are material to the risk and return of the investment, alongside traditional financial factors, when making investment decisions. The integration of ESG factors in the research process is typically a way for investors to supplement traditional financial analysis. What’s at stake here is how aware a company is of the relevant risks to its business, and how well it is managing them.

3. Thematic investing

This category sits right in the middle of the sustainable investing spectrum. Accordingly, a fund in this group might have more of a profit focus or might be more concerned with personal values. You will need to look under the hood, read the objectives and be satisfied that the manager’s interests are aligned with your own.

Thematic investing is about investing in sectors, industries, or companies that are expected to benefit from long-term macro or structural ESG-related trends. Investing in a sustainability theme does not necessarily mean you are committed to changing the world for the better. It might just mean that you have seen which way the wind is blowing (literally, in the case of renewable energy) and recognize the long-term investment opportunity a sector or theme represents.

4. Stewardship

This category is unique because it’s all about voices being heard. It’s the use of investor rights and influence to protect and enhance overall long-term value for clients and beneficiaries. This could include voting on management and/or shareholder resolutions in accordance with certain ESG-related considerations (proxy voting) or interacting with the management of the company through meetings or dialogue, typically to positively influence their activities or behaviour (engagement).

For example, if you notice that a company has set out net-zero targets, you can engage with the company to ensure that there’s adequate disclosure and clarity regarding the targets, and that the company is monitoring those measures.

5. Impact investing

The final category is arguably the most interesting to those investors who see their money as a mechanism for creating a better world. As the name suggests, it includes funds that seek to generate a positive, measurable social or environmental impact, alongside a financial return. It might, for example, include investments in social housing or businesses that are trying to create jobs for ex-offenders. It may also include investments in companies that have a specific emissions reduction target, in line with the investment objective.

And there is a spectrum within the spectrum here, because funds may have differing demands of their investments with regard to the financial returns they deliver alongside their ethical impact. Again, it’s your decision as an investor how far toward philanthropy you want your impact investing to veer.

This provides a simplified view of a fairly complex picture. Not all funds will fit neatly within one category. A fund that applies a ‘best-in-class’ strategy may also apply ‘ESG integration’ as well. Hopefully, however, this provides a starting point for your exploration of the world of sustainable investing.