Welcome to the Green Investor, powered by Investopedia. I’m Caleb Silver, the Editor-in-Chief of Investopedia, and your guide and fellow traveler on our journey into what it means to be a green investor today, and where this investing theme is headed in the future. We’re going to break format this week and get straight to a conversation on ESG from Investor Connection, an individual investor-focused event we hosted in partnership with Morningstar this week at our offices in New York City.

What’s in This Episode?

I participated in a panel on ESG—environmental, social, and governance concerns led by Leslie Norton, Morningstar’s Editorial Director for Sustainability; Jon Hale, Morningstar’s Director of Sustainability Research; and Carol Liable, the CEO of Domini Impact Investments. For context, Domini is a women-led investment company that has been around since the early 1990s and has been focused on impact investing to drive positive outcomes for the planet, while delivering financial returns—They’ve been in this space a while.

Morningstar, in case you didn’t know, is a giant financial services firm that offers everything from top-notch research, stock, ETF and mutual fund ratings, and investment management services. It’s one of the standard bearers for ESG ratings, and has hundreds of tools, ratings, categories, and indexes that help investors learn more about potential investments. We covered everything in this conversation, from the recent controversy surrounding ESG, to how individual investors can build portfolios that truly align with their beliefs. Here is part of that conversation, and we’ll link to the entire panel and all the panels from Investor Connection in the show notes:

Leslie: “Welcome, everybody. It’s really a delight to be here, and thanks to you for coming, and our previous panelists as well for giving us such an interesting panel. Sustainable investing has obviously been one of the most popular trends in investing over the past five years. It’s been shadowed by a cloud. Over the past year, as Caleb described, you’ve seen concerns about greenwashing. It’s been accused recently of being woke capitalism, as well as a tool of manipulative CEOs trying to impose their liberal values on America. Recently, the state of Texas decided to ban certain investment managers who practice sustainable investing from managing its public pensions. That affects one of the panelists here, but I’ll let her tell you about it. Now, Caleb already described the title of our panel. We have an excellent lineup of people to unpack this subject, so let’s just go ahead and start off. John, we’re now navigating through a time when ESG is perceived as controversial. Tell us what’s happening in this space during this period.”

Jon: “You know, I think it is obviously true that ESG is seen as controversial in some quarters. We’ve seen it in politics recently, as right-wing politicians have been attacking ESG. I think when you look inside the investment world and even among corporates, ESG is not nearly as controversial of a subject. It’s one, however, that carries with it a fair amount of confusion, both, I think, among investors and, I think maybe to some degree among corporates as well. But, you know, I think we’d all get a better handle on the whole thing if we kind-of made a distinction between ESG as a process—a part of investing that’s become a relatively mainstream component to the way investors make decisions—ESG as a process, and ESG as a product.”

“I think when you look at ESG as a process, most investors will tell you—most asset managers and fund managers will tell you that ESG is a set of information that we have, a set of metrics, ratings of companies and so forth, that help us develop a bigger, more holistic picture of an investment for the decisions we make. And ESG analysis is simply the interpretation of that information in order to make a good investment decision. And I can just tell you that, when you look at any asset manager of any size or significance in the world today, almost all of them are incorporating ESG into their process in that way.”

“So it’s not controversial per se, it’s one of these things that everyone’s doing, although it’s happened very quickly. If you go back ten years or so, the kind of ESG information we had then—there was some there—but it wasn’t nearly as sophisticated or voluminous as it is today, and there certainly wasn’t as much ESG analytics happening within mainstream investing. But a lot of the criticism of it is really just professional investors doing their thing, trying to live up to their fiduciary responsibilities, to look at all the risks, all the material risks that might be embedded in a particular investment or investment decision that they need to make. So it’s not values, it’s not politics—it’s just professional investors doing their fiduciary duty.”

Leslie: “Caleb, I want to ask you something. You know, you deal a lot with individual investors. You host a podcast that’s about climate and its intersection with the markets. Among these investors that are concerned about climate issues, that want to invest sustainably, is greenwashing a big concern?”

Caleb: “I don’t think it is, as much as them really just trying to figure out how to invest in alignment with their environmental sensibilities, or with their consciousness. We get a lot of questions on Investopedia about what really is ESG, what are the criteria? How do I invest in climate—in companies that are trying to reduce climate change or global warming? So it’s the how-to and then the unpacking of that. We did this survey last year with TreeHugger, one of our partner companies here at Dotdash Meredith, about what people thought of it and what they thought ESG meant, and what brands they associated with it. And to your point, a lot of brands that you wouldn’t necessarily think fell into that bucket—fell into that bucket because they had that perception. Tesla, obviously, it makes EVs—batteries for EVs and electric vehicles, but—it’s got some societal and governance concerns. But people think it’s a green company because it makes EVs. And unpacking that and really understanding the rules of that—it’s still confusing for a lot of investors, although there’s undoubtedly this wave—this movement of people who want to align their money with their beliefs.”

Leslie: “Right. Well, this gets us to the question of impact, right? Carol, I’m going to ask you to address this, because, you know, a lot of the confusion over the past year, people sort-of assumed, or some people assumed, that an ESG fund was supposed to deliver impact, and lo-and-behold, they discovered that it didn’t—that the ESG fund was investing in companies that were trying to avoid risk, but not necessarily trying to deliver particular societal outcomes. So, tell us about impact—tell us, is this a part of what you do? Is this part of ESG investing as we understand it now?”

Carol: “Thanks, Leslie, and thanks to John and Caleb for presenting alongside of me today. I think John hit the nail on the head when he was saying there’s work to be done, as you’re approaching a sustainable investment product and decide if it’s right for you. I don’t think it needs to be overwhelming. At Domini, we say, when thinking about impact, or ESG, or sustainability—think about it less of what you call it, and more about what you do. So we think about impact as having three levers you can pull. The first is to include environmental and social standards in your investment process. So we think about that application of those ESG standards under an umbrella, and that we refer to as being better investors.”

“The second is, now that you’re an owner of these companies, you have a voice at the table and you can create change where you see weakness. So Caleb referred to Tesla, a company that is electrifying the automobile fleet and changing the way we all drive—is very powerful. So having that seat at the table, and approaching them about some of the employee-related issues that they’re facing gives you another level of impact. And we put that under an umbrella which we call being better owners.”

“And the third, which we think is critical to the infrastructure and thinking about it at a system level, is to invest in communities. Sometimes people are a little confused by that. How does that impact my portfolio? Well, we think all portfolios have to be built on a sound financial system, which includes fairness and justice for all. So channeling money—often through fixed income, but also through diversified financials, banks, insurance companies, is a way to help us build healthy, vibrant communities. And we put that into the pillar of being better neighbors. So being better investors, better owners, and better neighbors are the three tools that ESG has as a strategy. And the question you should be thinking about, as you’re approaching each product, is how many of those levers do they use, and to what degree?”

Leslie: “Thank you, Carol. I’ve got to ask you this: your funds are now being disqualified for investment by the state of Texas. What an outrage. So how has that affected your approach?”

Carol: “So I’ll say, frankly, it hasn’t, and I think that’s reasonable. Our standards, at Domini—we apply one set of standards to all of out mutual funds. So we don’t change the standards depending on the product. We really think about them as a brand, and apply them across all of our products. So, to be very transparent to all of our investors, and to also serve as the backbone of all the work that we do, we publish those standards on our website. You can download them as a PDF, they’re about 70-plus pages long, and they provide very detailed information about what we’re doing and our approach.”

“Again, as John says, going back to giving the investors those tools to decide if this is a product that’s right for that. We think that this detailed information is what draws a lot of our investors to us. Our approach of excluding the energy sector, not only refiners and producers, but also those companies that service them, like transportation companies or storage companies that are very closely connected to that activity, are excluded as well. So we think that providing that detailed information, putting those standards out there, and really letting the investors decide whether our approach is the right approach for them will continue, despite the Texas ruling.”

Jon: “Well, I think it’s really important for sustainable funds to be very transparent with their investors. I think if you look at it, kind-of think of sustainable products more generally, and the tremendous demand that’s out there for sustainable products. Sustainability is kind-of a component to the decisions that we make in all facets of our lives, whether it’s consumer decisions, whether it’s lifestyle decisions, career decisions—it only makes sense that it would also happen with investments. But I think for any kind of product that’s making a sustainability claim, we’re dubious, right? Caleb mentioned greenwashing—we want to guard against being taken for fools, right?—about selecting a product that says it’s sustainable.”

“So we want the proof, and, you know, a product really only has one chance. When somebody is on the hook getting ready to buy this product, we need to demonstrate our credibility when we claim it’s sustainable. And I think what’s happened with a lot of funds—a lot of them have launched very quickly and some, frankly, from large asset managers who, you know, this might be the one single sustainable or ESG fund that they have in a lineup of hundreds of funds. And, they really haven’t attended to that challenge of saying, you know, here’s our case—here’s why this particular strategy is sustainable, and why somebody that’s interested in this can be comfortable buying this product. And so, I think transparency on the part of the fund product is very important, and making very clear what approach, or combination of approaches that they use, is what the investor’s going to get when they purchase this product, essentially.”

Leslie: “Well, let’s talk about some of those approaches. I mean, you actually hashed out a framework that had six—here may be more than that, but these were six, basically. What are they, and how do you see them reflected, say, in Carol’s fund?”

Jon: “Yeah. So we’ve already talked about ESG analysis. I kind of broke that down into two different kinds of approaches. One—probably the most common way to use ESG information in an investment decision-making context is in terms of risk management. You talk about what are the material ESG risks that a particular company faces, or a particular industry faces. So a lot of investors are using ESG in order to help them manage risk, or get a more complete picture of the risk of an investment—that happens across the board.”

“As I was saying before, that’s kind-of a mainstream activity now among investors—that’s a very common, really the most common way of using this ESG information. But sustainable funds often also use it to identify opportunities—to focus, for example, on how ESG information helps them find the sustainability leaders industry-by-industry, for instance. So that’s another way of doing it—risk opportunity.”

“Exclusions—everybody’s probably heard of exclusions, and that’s something that’s been happening for a long time in these types of funds. There could be out-and-out exclusions that are used—a lot of ESG or sustainable funds have a list of certain exclusions of types of products or, in some cases, complete exclusions of fossil fuel industry firms, although not all do that. So that’s another one—exclusions, risk opportunities, sustainability themes, a thematic approach. Domini has a fund like that—Sustainable Solutions, right? So it’s focusing really on sustainability as a long-term theme. This focuses on renewable energy and clean tech, and those sorts of things as well. Some funds are really more focused on impact than others, in terms of how we assess the overall impact of the holdings that we have on our portfolio, and how do we communicate that to our investors. So that’s another approach.”

“And then finally, engagement and proxy voting and things like that—focusing on trying to further improve ESG behavior at companies that you own in your portfolio through engagement, and proxy voting. This is something that’s happened for a long time, even going back into the seventies and eighties. But, you know, at the time it was a very small number of people doing this. Frankly, at the time, you had to bring a group of Catholic nuns or something like that with you to the table to get the companies to have a meeting with you. Today, it’s so different—the companies themselves are very interested in ESG, they’re very interested in how ESG assessments help them kind-of understand how to shift their approach to the business, towards, you know, more sustainability, and more focus on all the stakeholders that the company serves.”

Leslie: “Caleb, many investors are interested in specific themes, or in single issues. How do they invest around these themes? What would you advise them; how are you guiding them in the articles that you publish? Or, is it better to pick a broad sustainable fund?”

Caleb: “Well, to their points, there’s a flavor for almost any one of these themes, and there’s an idea for that—for sure, or there’s a good mutual fund you can buy as well. So you can really pick your themes and go really deep on that theme if you want. He mentioned climate, climate tech, water, water tech, water purification, food, food tech, agri-tech—that’s becoming very big. So our readers are interested in all of these things—we have a lot of readers, and they all come from various backgrounds, but they’re looking at approaches to the things that they’re passionate about, typically.”

“And then there’s the overarching investor who’s not necessarily that interested in particular themes—they’re just interested, again, in aligning their dollars with their beliefs. And they don’t want to be in certain sectors, or they want to be able to screen them out. So we’re seeing the rise in popularity of tools like Canvas and others, that allow you to do screening, take things in or out of your portfolio, or add a little bit here or add a little bit there.”

“People are interested in learning more and more about that, but I would say there is this pretty decent chunk of people—and I think it’s most people who just want to do right, and they just don’t want their money going to things that they don’t believe in anymore. So they’re going to find that ETF that excludes it, or they’re going to find the ETF or the index fund that concentrates on the thing they want the most. And then we have folks who want to be actively invested in companies like Engine No. 1, and others who want to own shares in companies, so they can have a voice in what they do. And you see more and more folks getting into that, because they want a seat at the table—they don’t want to just say, “I’m just not going to put my money there,” because some folks don’t believe that is the only solution.”

Carol: “And I’ll just piggy back a bit off of Caleb’s remark. What we find when we’re building our Domini impact investment standards—we’re using the lens of what the classic impact investor is looking to implement in their portfolio. So often an investor will come to us with one theme that they’re looking to head, but then they’ll see through the standards. I’m going to get all of these other things, and I’ve had investors say, “Oh, we get all these other things for free.” It’s like, I’m getting the thing I want, plus more. And another thing that we’ve heard through studies and surveys we’ve done with our shareholders is that they trust the expertise—that long term historical perspective on these issues. They want to leave that to the expert and try to make that decision on their own, and they’re a great source to do that these days.”

Leslie: “That’s great. In fact, you’ve sort-of answered this question, but I’m going to pose it nonetheless, because it’s a question that’s repeatedly asked in every article I currently read about sustainable investing. Can you really make a difference in the world if you practice sustainable investing?”

Carol: “Yes. We are very committed to reporting out to our shareholders—on both a quarterly and an annual basis—on what difference a dollar invested in a Domini fund has made. That is a really important answer for investors, and that’s been part of the evolution. So, when we first started 30 years ago, you know, the first question was like, “Well, how are we going to do this? Where are we going to get this data?” Well, now we have lots and lots of data thanks to the pioneers of the space—pioneers in the space requesting the data. We have tools to measure, manage, and make the evaluation of whether a company meets our standards or not.”

“The second question was, “Well, how would it perform? Is this going to cost me money?” And luckily, with 20-plus years of data now, and lots of studies—meta studies and studies of indexes, funds and companies, we see that it can perform competitively. So there is not an inherent cost and there’s not more risk than needs to be taken on. But you have to do your due diligence and be careful, just like for any other investment product, about who’s managing your money.”

“And then the third and most recent question has become, “Well, what difference does it make? Where can I see the results? What are you doing?” And that was what really pushed us to put that quarterly and annual reporting out there.”

Caleb: “Yeah. I mean, again, with those very directed types of ETFs or companies—if you want to invest directly in those companies, then you can actually see where your money’s going, and you can actually see how the company is putting it to use by following up with that company. Same thing with ETFs, although it’s a little bit wider, it’s a little bit more of a scattershot approach. But, I think performance has been the big question for years, and then it really kind-of went away until we had this supercycle in commodities kick in, and then all of a sudden everybody’s wondering, “Well, I’ve been out of the market—I’ve been out of, you know, energy stocks, traditional energy stocks for a while, and I missed pretty much the only returns that have been available in the stock market. How deep is my conviction to investing along with my environmental beliefs, when I’m missing out on returns?”

“And this has really put the industry to a test, along with all the regulatory issues that may be coming down the pipe. A lot of this is really making investors ask themselves that very hard question—you said you believed in it; this is where you wanted to put your money. Now you actually have the opportunity to defend that in the face of rising commodity prices, a lack of performance by a lot of sustainable and ESG funds, and the fact that there may be regulation overarching and overcoming this entire industry here.”

Carol: “And I think it’s important to acknowledge that environmental and social research is really a matter of looking at trends and patterns over time. So it’s really looking out over a medium and long term. There will be short term volatility. So I think when you’re approaching it, you have to acknowledge that, and have the investment goal so that you can ride that out over a longer term. If you look at energy, we find it goes up and it goes down, but it’s fairly neutral over the longer term.”

“And our exclusion of energy, yes, has huge environmental impacts, huge social impacts. But we also believe it’s going to have a huge financial impact because, frankly, if we burn all of the oil we have in the ground, we won’t have a planet to live on. So at some point the party’s going to come to an end. How and when is an important consideration. So—long term lens—riding out some of some of the cycles, and it’s been a tough one when energy was the only thing performing—for sure.”

Leslie: “John, you wanted to add something really quickly, then we have to move on to our next questions.”

John: “Well, I mean, one of the things I wanted to add about impact was that—if you look at the amount of money that’s gone into sustainable funds, and the amount of attention that asset managers now pay to ESG information and analytics—it has sent a giant signal to corporates the world over, that ESG matters are important to investors. And corporates have heard that, they’ve also heard that from their other stakeholders—their employees in particular, and customers and partners and community, everyone. But when investors also weighed in and said, “This is important,” it has started to change corporate behavior. And it’s a massive—I think—paradigmatic shift away from shareholder primacy as the focus of corporate management to stakeholder value, and the long-term perspectives that go along with that.”

Carol: “Well, a lot of people wanted to count—and that’s a logical thing to want—but when you’re thinking about impact, it has to be both quantitative and qualitative. So we can measure through carbon footprinting that our portfolios are less carbon-intense than others. But there are times when you’re looking at an issue that it has to be, as John is saying, a full stakeholder evaluation of “Is life better if you have as much money as possible in your account, but you have no clean air to breathe, or water to drink, or if your house is underwater?” You know, that’s the overall wellbeing and the impact that needs to be answered.”

Caleb: “We’ll link to that entire conversation led by Morningstar’s Lesley Norton with Jon Hale, Morningstar’s Director of Sustainability Research, and Carol Liable, the CEO of Domini Impact Investments, and me, in the show notes. And you can also check out all the great conversations and learning sessions we hosted this week at Investor Connection, the first-ever partnership with Morningstar and Investopedia. That was a lot of fun, and a lot of good education about how to reset our investment strategies for the rest of this very challenging year.”