Investments in sustainability

Sustainable investing (which is a facet of something often known as socially responsible investing) puts a spin on the way that investing is normally done. For typical investment decisions, investors think about how to place their money based on the principles of risk and return, how much money one stands to make but also how likely it is that some or all of that money could be lost. Everyone is looking for investments with high return and low risk. Sustainable investing looks at risk and return, but adds another component, the impacts that these investments will have on sustainability – the environment, ecosystems, greenhouse gas emissions and more. Sustainable investors are looking to do good (for the planet) while also doing well (making money). Good sustainable investments are those that provide a solid financial return while also reducing impacts on the environment, the so-called “double bottom line”.

Greenhouse gas emissions are often the way that environmental impacts are measured when looking at sustainable investing. Other things such as biodiversity, ecosystem or human health could also be used, but can’t be quantified as easily. Carbon dioxide and other greenhouse gas emissions do present an existential risk to humanity through climate change, so using CO2 reductions as a measure of the success of sustainable investments is a reasonable place to start. We think that the best way to measure the sustainability returns of a particular investment are to compare it to the status quo – If you didn’t make a given investment, what would happen? Then if you do make that investment, how would things change? What pollution would be avoided, what land would be better managed?

And how should we value any reduced CO2 emissions? If one wants to put a dollar value on them, you can assume a social cost of carbon, which we go into in greater detail on another page. The main idea of the social cost of carbon is that each ton of CO2 pollution has an environmental and societal cost, which should be figured into spending decisions. The problems for an investor are twofold. First, it is hard to get a precise estimate for what carbon pollution should cost, with estimates ranging from tens to hundreds of dollars per ton. Second, this benefit is very diffuse, going to everyone in the world who will benefit from keeping the climate more stable, which is very different than a personal financial return. A good initial goal for an individual or an organization would be to seek to offset their own carbon emissions, to do enough good elsewhere to make up for their own consumption. If everyone were to do this, we would quickly approach net zero emissions.

So where should a person invest more sustainably? Broadly, one could invest in one’s personal household, at the level of one’s local community, or through the stocks or bonds of larger companies that have more sustainable business practices. We’ll expand on each of these below.

Investing in your own household. People don’t always think about the changes that they make in their lifestyles as financial investments, but they certainly can. These are all of the things that we purchase and use in our lives that affect our finances and they can vary in sustainability tremendously. For instance, some of the sustainability investments that one could make in one’s own family would include re-insulating one’s home, purchasing a different home that is better built or would reduce future travel needs, putting solar panels on the roof, buying an electric car, and much more. Again, the way to evaluate these sorts of investments is to look at how they relate to the status quo, and compare to what would have happened if you had followed the ‘typical’ pathway. These sorts of decisions need to be evaluated on a case by case basis, as the details make or break any given investment choice. A couple of examples can demonstrate.

Say that you live in a typical 40 year old home. You get a home energy assessment done, and the technician suggests that you put $15000 into insulation and air sealing upgrades. Is this a worthwhile investment? To evaluate it, one should look at the finances but also at greenhouse gas emissions. Perhaps your home is heated with natural gas, and your annual bill is $3000, producing 12 tons of CO2 per year. After the upgrades, it is estimated that your gas usage will be cut by 1/3, yielding an annual bill of $2000, and 8 tons of CO2 per year. This $1000 a year in saved natural gas costs will pay back the cost of the work in 15 years, meaning that you are getting a 5% return on your investment and the savings will continue for much longer than that repayment period. At the same time, you are getting the added benefit of reducing carbon pollution by 4 tons per year. There may be some higher yielding investments out there, but this would be one that has a decent return, is low risk, and also nets good greenhouse gas reduction.

Or perhaps you are in the market for a new car. The status quo choice would be a gasoline powered car, while a more sustainable choice could be a battery electric car. As of early 2019, the long term costs of ownership for comparable gasoline and electric cars are quite similar. Electric vehicles cost more upfront, but then have significantly lower fuel and maintenance costs. As the total cost of ownership is about equal, the financial return of going more sustainable is negligible. There is, however, an average annual savings in CO2 pollution of 2 to 4 tons per year – the pollution from making the electricity is generally much lower than in burning the gasoline. So while battery powered vehicles have some trade-offs, one can now buy a new electric car instead of a comparable gas powered car and essentially get the environmental benefits ‘for free’. It is predicted that by the mid 2020s that electric vehicles will become cheaper to purchase than their gasoline powered cousins, and then both the financial and environmental returns will both favor electric.

Community or personal business level investments. By community level, we want to refer to those investments that one could make where it is clear where the money is going, what sorts projects it will be invested in and what effects they may have (see a primer here). This could be done by putting one’s money where it will be used to do things like build higher quality affordable housing or improve community infrastructure. Maybe it would be structured as ‘green’ bonds or loans to causes deemed worthwhile. If you are a landlord, business owner or manager, this could mean improving the sustainability profile of your buildings or business.

Where we live in Ottawa, there are a couple of community energy cooperatives, OREC and CoEnergy. These organizations issue bonds in order to build solar projects and do larger scale energy efficiency improvements in buildings. For instance, OREC may put together a proposal to build a solar installation with 1000 solar panels. This requires an investment of several hundred thousand dollars upfront, but then will earn money for the next 20 years or more selling the electricity generated back to the grid. An individual investor could invest $10,000 into OREC and that money would go straight into building this solar installation and in return the investor would get a 4% annual dividend ($400 per year). Additionally, each $10,000 share of the project would offset almost 2 tons of carbon dioxide per year. This is because adding more solar electricity to Ontario’s energy grid directly reduces power coming from other more polluting sources. This is functionally very similar to putting solar panels on your own home, but without all of the hassle of managing it personally.

Sustainable investments in stocks and bonds. Stocks, bonds, mutual funds, ETFs, these are the kinds of things that people more commonly associate with investing. When you buy stocks, you are becoming a part-owner of a company, and when buy a bond, you are purchasing a loan that has been made to an organization. Mutual funds, index funds, ETFs (exchange traded funds), these are all simply clusters of stocks or bonds that one can purchase as a group instead of buying each of them individually. Each company and government has a carbon footprint and ecological impact that you become connected to when you buy in. You may not be personally responsible for that company’s impacts, but you are in effect endorsing them and profiting from their practices. If you want to promote sustainability with your stock and bond investments, you would want to invest more in companies that have good sustainability profiles and divest from those that cause more pollution or environmental degradation.

So what exactly is the link between investors and the levels of pollution and other damage caused by businesses? For the household and community investments mentioned above it is relatively easy to make a direct link between investment and environmental effects, but it isn’t so simple for stocks and bonds. In principle it seems like it should work the same at a larger scale, with more sustainable companies getting more money and being able to grow their business to do more of the good things that sustainable investors are rewarding. Likewise, divesting from companies with poor business practices should starve these companies of the capital that they need to grow their businesses. However it isn’t so simple. For one thing, not all investors are paying attention to sustainability, so if one investor sells some stock to protest that company’s practices at a slight discount, another will swoop in to buy the ‘bad’ companies because they are only looking at the direct monetary returns on that investment. Second, companies don’t directly make their money off of their stock price, but rather from sales of their products and services. Stock and bond values do have effects on a company, but it is a more indirect one. The takeaway is that it is currently unclear what effect an individual investor can have on publicly traded companies through their investment choices.

Divestment campaigns have been growing in strength in recent years (see here and here), particularly targeted at fossil fuel companies. The goal of these projects is to get large investment groups to sell off all of their fossil fuel investments and weaken the targeted companies. For the reasons mentioned above, these don’t seem to be having large direct impacts on the companies, but rather act more as a media tool to change the narrative and norms in such a way as to make fossil fuels less appealing or even to be considered ‘bad’. This changed narrative then encourages people and organizations to change their own consumption, or to push for tighter regulation from governments such as the adoption of some sort of carbon tax.

Then there are the active investment into particular sustainable or ‘green’ companies. When buzz builds and investors pour in, this certainly does help these companies – it become much easier for them to borrow money, increases their profile and brand awareness, and more. With sustainable technologies, such as wind, solar, batteries, or electric cars (and tech companies more generally), people are usually betting that these companies will grow and make more money in the future. A company’s current sales may not justify a high price, but people think that the company is going to sell exponentially more of their products into the future. However, if there are many companies competing to grow into an emerging field, it is really difficult to predict which companies are going to win out. There have been a lot of solar, wind, battery, and electric car companies that have gone bankrupt. So, as with divestment, there probably is some positive effect on companies that are receiving extra investment for their good sustainability records, but it is very hard to know the size of that effect.

One relatively easy way to start investing with your values is to purchase what are known as ESG funds (environmental, social and governance). These funds often screen out certain industries as well as those companies that have poor records related to environment, social, and governance issues. To give one particular example (of many), Vanguard investment group now sells ETFs for both the US and international markets that are broad indexes screened for ESG features. So these particular funds exclude fossil fuel companies, nuclear power, vice products like tobacco, and weapons. They also exclude companies shown to have behavior not in line with the 10 principles of the UN’s Global Compact. These indices end up excluding around 20% of the stock market, leaving a broadly diversified fund that still holds 80% of the companies. It is by no means a perfect way to weed out the ‘bad apples’, but it is a good start. There is a flood of new investment products like these now entering the market as many people want more input into which companies they want to be involved with.

One more thing that is worth mentioning when talking about investments and sustainability is shareholder activism. This is when stockholders in a company use the leverage granted to them by their stake in a company in order to directly shape that company’s business practices. This is often about trying to encourage companies to make different financial decisions, but it is a tool now being used more often to pursue environmental or social justice goals. This kind of leverage is beyond the reach of most individuals acting alone, but can be a good target for collective action.

Conclusion. We think that a major takeaway from this entire discussion on sustainable investing is to focus first on local investment. It is much easier to know the links between investments and outcomes and one can be much more targeted with one’s actions. At the scale of publicly traded companies, it certainly doesn’t hurt to move your investments to sustainable companies, but don’t rely on them to have direct effects that you will be able to measure. We also think that it is still a viable option to have a more traditional investment portfolio that doesn’t give any preference to companies based on their sustainability, and then simply use some of the profits from those investments to take more direct action.