By Jeff Schlegel

Green investing. Socially-responsible investing. Sustainable investing. Different ways to say the same thing, or different ways to approach investing? Undoubtedly, some investors are confused by the nuances of the terminology, but there are clear differences, at least when it comes to SRI versus sustainable investing, said a panel on the subject at last month's Morningstar investment conference in Chicago.

To put it in simplistic terms, SRI is Negative Ned while sustainable investing is Positive Pete.

"What's changed is that SRI investing was a values-based approach seen as being about avoiding and excluding companies," said Stu Dalheim, director of Calvert Investment Management's shareholder advocacy program. "Sustainable investing is different because it's about looking on the pro-active and positive side about what companies are doing to try to find companies that will outperform their peers over the long term."

Dalheim added that companies seeking to manage issues like water shortages and climate and energy challenges--as well as those dealing responsibly with their stakeholders--positions themselves to do well. "Those are companies we believe will do better over the long term."

Ditto, said Jack Robinson, founder and chief investment officer at Winslow Management Co. "This has grown into a more positive approach," he noted. "With the advent of Whole Foods going public in the 1990s, we began to see companies that were part of the solution."

Robinson said so-called solution investing has been his company's focus in recent years, and that has expanded its universe of companies to choose from.

20% Of S&P

As for defining sustainable investing, Robinson breaks it down into three buckets. First, companies need to be profitable to be sustainable. Second, a company's environmental consciousness and strategy have a lot of financial implications, all of which are positive. Third, a company's overall social governance includes its commitment to both social responsibility and to its employees.

Robinson said roughly 100 companies within the S&P 500 have a general sustainability committee, and most of them have a chief sustainability officer. That's a quantum leap over even just a few years ago, and he posited that the trend will continue to grow because "if you're not going to get involved with sustainability as a corporation, you might not be here in a few years."

Morningstar mutual fund analyst Kathryn Young, the panel's moderator, said sustainable investing is a strategy that allows investors to simultaneously achieve market-beating, risk-adjusted returns over time while promoting positive social and environmental changes. Sustainable investing isn't entirely separate from SRI investing, she said, but is part of an evolution that focuses more on a pro-active approach versus looking at negative screens.

"It's gaining in popularity with investors and holds more promise in terms of risk management and the search for growth opportunities," she said.

Young noted that sustainable investing is increasingly attracting institutional investors. "We're seeing more institutional investors, notably CalPERS (California Public Employees' Retirement System) and CalSTRS (California State Teachers' Retirement System), who've made serious efforts to integrate sustainability into their processes," she said.

One reason for that, said Parnassus Investments research director Ben Allen, is that companies that earn high marks for sustainable investing are alpha generators that are viewed as part of the solution.

"For institutional investors, the more they see the results and the more research they see come out in this area from universities and business schools, the more it will drive that acceptance, Allen said.

Indeed, institutional investors want bottom line results; not feel-good fads. "What sustainability does for a company is reduce its risk because if you don't create an environmental liability, you don't have to clean it up and carry it on your balance sheet as a liability," Robinson said, adding that companies can enhance profitability through greater operational efficiency and reduced costs that often result from sustainable business practices.

Growing awareness of this broad trend is fueling more disclosure around sustainable business practices.

"More investors are paying attention to these issues, and more companies are producing information that's helpful and relevant to help investors understand the sustainability performance of companies," Dalheim said. "And that's driving a virtuous cycle now because there's more information out there, investors are paying more attention, and there's more information in SEC filings. More companies are putting information on sustainability and governance issues in their annual financial reports. So that's helping to spread the trend to mainstream investors."

Quantifying Risks

Allen says some issues germane to sustainable investing are more important than others, but things such as environmental regulation definitely need to factor into the overall investment criteria. "For us, it's just as important as understanding the margins and revenue growth," he said. "It's just another lens to understanding the intrinsic value and fundamentals of a business."

That said, he added there are no concrete rules to follow like with certain financial metrics. "It's not obvious finding out what these risks are, and the expertise we're selling is our judgement," he added, noting that Parnassus portfolio managers work with two internal ESG (environmental, social and governance) analysts who focus on these issues.  

Robinson concurred. "There really isn't a service you can subscribe to that rates how a company looks [from a sustainable investing perspective], so a lot of it depends on the internal analysis you do. And even with that, there are no cut-and-dry answers to that. It's really about how you approach it and look at it."

Robinson said his experience finds that companies that are environmentally responsible generally are socially responsible. It speaks to a company's culture, and another way to approach that is to look at a company's safety record.

"How important is safety to the CEO of a company?" Robinson said. "I find if they're paying attention to that, they're also paying attention to other aspects of responsibility."

How To Invest Sustainably

Some sectors, such as energy, present challenges to the sustainable investment approach.

Regarding its energy holdings, Allen said Parnassus generally invests in U.S. companies due to better corporate governance policies. It tends to favor natural gas because it's cleaner, but avoids companies plying the Marcellus Shale natural gas field in the Northeast due to water pollution concerns caused by hydraulic fracturing drilling, or fracking.

As such, Allen said Parnassus invests in gas companies in North Dakota and West Texas it has identified as drilling in a responsible way.

Elsewhere in the energy space, he said Parnassus frowns on coal and absolutely avoids nuclear.

Dalheim said Calvert sees natural gas as a bridge to address climate and national security issues, and it invests in companies involved with fracking. "Our approach is to engage them and ask them to be more forthcoming with foreclosure, and we've had some success with Devon Energy and Anadarko to improve their disclosure" about their fracking process, water disposal methods and the chemical makeup of their fracking solution.

"It's a difficult issue because natural gas is domestic, it's a lower-carbon fuel and it's a positive thing, but there are significant concerns regarding water quality," Dalheim said.

Robinson says Winslow looks at the alternative energy space from both production and consumption perspectives. "It's not just about producing wind, solar or geothermal, it's what can you do to reduce the consumption side," he said.

On the production side, Robinson likes First Solar, which he called the leading solar company both in terms of its technology and manufacturing processes. He also spotlighted a small Ft. Wayne, Ind.-based geothermal company called WaterFurnace that makes geothermal heat pumps for shallow geothermal operations. He noted the company consistently produces return on equity of 40%, and it pays a dividend.

On the consumption side, he spotlighted a small Canadian company called Pure Technologies that--among other things--measures water leaks in municipal water systems to help reduce wasted water.

Sustainable investing might be gaining momentum among both institutional and mainstream investors, but the concept still faces headwinds due to the current state of U.S. energy policy, or the lack thereof.

"There hasn't been a consistent, comprehensive framework that helps provide guidelines for investors to direct money to lower-carbon technologies over the long term," Dalheim said. "We've seen examples of countries who've done it better and have had more growth, such as Germany."

That means U.S. companies have been reticent to make long-term investments in green technologies, and that investors by-and-large have been sitting on the sidelines until the policy picture--such as some form of carbon tax--become clearer, Dalheim said.