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Crafting the Right Approach to Sustainable Investing


How can individual investors incorporate sustainability into their own investment approach?

My previous post on sustainable investing introduced the concept and concluded that making sustainability a focus or a part of your investment criteria can help reduce risk, while generating better risk-adjusted returns. In fact, earlier this year, Harvard University "agreed to create a senior position at its investment management arm to consider the environmental, social, and corporate governance (ESG) aspect of its holdings." (Source: The Boston Globe, Business Section, Article: "New VP will scrutinize Harvard's investments" February 19, 2013 by Todd Wallack). But a question remains: How can individual investors incorporate sustainability into their own investment approach?

The truth is that sustainability is a broad concept that varies greatly by individual. And this means that implementing a standardized practical approach can be difficult. That said, a good first step might be to consider the current environmental, social, and corporate governance record of your holdings. Evaluate what plans or strategies each company (holding) has in place to address issues such as resource scarcity, environmental degradation and social injustice.

By analyzing a company's ESG strategies, we can gain insight into their willingness and ability to plan for both the present and the future. Facing challenges such as climate change, resource depletion, and demographic and social shifts, companies that plan accordingly should be able to reduce risk over time, lower the cost of capital, and improve both short-term and future risk-adjusted performance. On the contrary, a company with inadequate or poor ESG strategies suggests that performance in the short term may be at the expense of acceptable long-term performance. (Source: Sustainability in Investment, We Need a Bigger Boat, August 2012, Towers Watson)

In addition to evaluating ESG factors, I like to look at a company's ability to innovate. Does management have a track record of being able to effectively change course, break with past practices in order to deliver new products, and processes and drive internal change? A company that demonstrates an ability to innovate and change suggests that they take an intergenerational approach to delivering value, thus a more a sustainable investing approach.

For a long time investors have been able to ignore sustainability factors when developing an investment plan. In fact, I am sure that many investors will continue to generate excellent above market returns without considering the sustainability of the businesses in which they invest. However, as the world continues to change at an ever increasing pace, I believe that those companies with transformational sustainability strategies and risk management frameworks will outperform, while those that attempt to survive by continuing to adapt incrementally will simply be unable to keep up.

This article by Joshua Schroeder was originally published on See It Market.
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