Can Climate-Conscious Investing Stem Portfolio Volatility?

Leo Maheras |

Experts have warned that today's major market indexes haven't adequately priced in the cost of the impending climate crisis. As the market's initial reaction to COVID-19 has shown, any delay in response to an imminent threat can leave investors vulnerable to sudden and serious downturns.

Some investors are responding to the climate crisis by gravitating toward companies and investment offerings that have already begun to make changes toward improving sustainability. Learn more about how socially-responsible investing (SRI) may hold the answer to minimizing portfolio volatility.

What is Socially-Responsible Investing?

SRI is rising in popularity, but it's not a new concept—environmental, social, and governing (ESG) investments that prioritize social good over pure profit have been around for years. One of the most well-known examples includes mutual funds that have specifically avoided investing in "vice" industries like tobacco companies, breweries, and casinos.

While these funds still have some profit motive—in other words, a company with poor financials won't pass muster just because it has noble social goals—shareholder profit isn't the only motive. This profit must be balanced with social aims designed to make the world a better place.

Today's SRI funds often target climate-conscious investors by focusing on companies and products that promote sustainability, work to reduce waste, and innovate products that directly combat pollution. SRI investments can range from exchange-traded funds (ETFs) to individual stock choices. Today's investors have more choices than ever when it comes to creating a socially-conscious portfolio.

How Can SRI Stem Portfolio Volatility?

Though the U.S. (like the rest of the world) is experiencing more and more ill effects from the warming planet, climate change remains an incredibly politically-charged topic. The government has only recently begun to consider practices and policies to combat climate change, such as denying rebuilding permits to coastal homes whose shoreline is slowly being encroached on by rising seas. Some states have taken steps like banning plastic bags or imposing additional fees and taxes on heavy polluters, but as time goes on, more sweeping measures will likely be needed.1

Experts caution that these measures aren't being priced into today's markets. Once they come to fruition, portfolios may find themselves exposed to unprecedented risk, and combating climate change may not yield quick or easy results. The longer the government waits to act, the more disruptive any climate-change policy is likely to be.

SRI can combat this risk in two respects. First, by investing in companies that are already planning and preparing for the climate of the future, you're less likely to suffer market whiplash as companies come to terms with the sweeping changes they'll need to make. Additionally, many SRI funds are naturally diversified in that they span multiple different industries and product sectors. This diversification can help protect against the sudden downturns that can happen when one particular industry (like banking, travel, or housing) is being walloped by market forces.

By investigating your SRI options now, you may be better prepared to navigate through future turbulence.

Important Disclosures:

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies. Please keep in mind, the return on values based investments may be lower than if you make decisions based solely on investment considerations. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio.

Diversification does not protect against market risk.

The information provided is not intended to be a substitute for specific individualized tax planning or legal advice. We suggest that you consult with a qualified tax or legal advisor.

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