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A Long-Term Commitment to Sustainability Can Help Investors Weather Short-Term Market Turmoil

But some sustainable investors may want to adjust their style exposure.

How should you react to market volatility? It’s a pertinent question for any investor given that the stock market reached correction territory this week just before Russia invaded Ukraine. For long-term investors with a diversified portfolio, the best choice is to stay the course rather than reduce or liquidate your equity exposure in reaction to events like this week’s.

But if you are a sustainable investor, you may have additional concerns. Many of you are among those who have poured billions into environmental, social, and governance equity funds over the past several years during markets with favorable tailwinds for ESG investments. Not only have markets declined during the first two months of 2022, many sustainable equity funds have lagged their peers. Pricey growth stocks that tend to be over-represented in many ESG equity portfolios have taken hits in the correction, and value stocks, including fossil-fuels-based energy stocks, have led the market.

If you have a significant ESG-driven growth tilt to your portfolio and your year-to-date returns are causing you too much discomfort, that’s an indicator that you may need more stylistic balance in your portfolio over the long run. You can do this by adding value funds to your portfolio.

Beware, though: markets have already moved a lot, so reducing growth exposure at the moment risks missing out on a growth-stock rebound. But gradually adding value to better balance your style exposure over the long run may help you rest easier during future bouts of volatility.

A Word About Sustainable Value Funds

While it’s harder to find sustainability leaders on the value side of the spectrum, it’s far from impossible. There are 15 sustainable funds in the large-value Morningstar Category, including Calvert U.S. Large Cap Value Responsible Index CLVRX, Nuveen ESG Large-Cap Value ETF NULV, and the actively managed Parnassus Endeavor PARWX. Compared with value funds in general, ESG value funds have less exposure to traditional energy and utilities stocks. They tend to offset those underweightings with overweightings in financial services, industrials, and consumer defensive stocks.

It’s true that growth stocks tend to have better ESG credentials than value stocks. But ESG value funds can help companies improve their sustainability profile through active ownership.

And Another About Active Ownership

Indeed, one of the great untold and still unfolding stories of sustainable investing is the impact that is being achieved through active ownership. As equity owners, sustainable investors can engage with companies about ESG issues, they can sponsor shareholder resolutions formally asking companies to address ESG issues, and they can vote their proxies in favor of those resolutions or register their disagreements by voting against board nominees or executive pay packages.

I call it a great untold story because I don't think investors know much about the active ownership activities undertaken by many sustainable funds. This is partly because, until recently, most direct engagements with companies were not disclosed and the vast majority of votes on shareholder resolutions garnered very little support.

And I call it a still-unfolding story because, along with the growth in sustainable fund assets has come far more active ownership activity, more shareholder resolutions, and, especially notably, far greater support for ESG-related shareholder resolutions by investors of all types.

To learn more about these activities, check out the "2022 Proxy Resolutions & Voting Guide", published by the Interfaith Center on Corporate Responsibility, an organization that has been around for five decades with a membership of institutional investors and asset managers who today represent more than $4 trillion in assets under management.

ICCR members have filed a record-breaking 436 proposals (and counting) this year. Close to half of these resolutions address the climate crisis; racial justice; and diversity, equity, and inclusion. Other notable topics include calls for greater disclosure of corporate political activities, which stems from companies saying they would stop contributing to politicians who supported the Jan. 6, 2021, Capitol insurrection and then quietly restarting their giving, and from companies that claim to be committed to climate action but contribute to trade organizations that aren’t. Tech companies face heightened scrutiny from proposals related to the use of surveillance technology, data privacy, and the spread of misinformation.

Active ownership is what really sets many sustainable funds apart from more-conventional ones. These activities are having a clear impact on public companies as they move to respond to demands from a significant and growing segment of their investor base to address material ESG issues they face and to embed sustainability concerns into their business models. If you own a sustainable fund, it should be publishing a report on its active ownership activities.

Not only is active ownership having a broad impact, it’s also an activity that can and should help sustainable investors forge a deeper connection with their investments. And that, in turn, can help sustainable investors keep their focus on the long term and stick with their investments during periods of market volatility.

And a Final Word About Commitment

Look at it this way: All investors invest to receive the risk-adjusted return they require to reach their overall financial goals. In so doing, they are getting what's known in the behavioral-finance world as a utilitarian benefit that results from their purchase of an investment product.

But beyond the purely utilitarian benefit of investment returns, sustainable investors may also receive emotional and expressive benefits from their investments. The decision to invest in a way that reflects their values and makes a difference is literally an expression of who they are and how they see themselves in the world. This is what behavioralists call an expressive benefit. And the decision to invest sustainably makes investors feel good about themselves and their decisions, conferring an emotional benefit.

Our esteemed colleague Don Phillips wrote about this recently in "A Better Case for ESG": "When a portfolio becomes a cause, investors are apt to be more dedicated to it... . People want to believe they are part of something bigger, that their actions have significance to the world around them. ESG-themed funds hold the potential to forge such bonds."

With a deeper commitment to their portfolios, he continues, sustainable investors are more likely to “stay the course when others abandon ship.” And if that’s the case, sustainable investing “will be performing a valuable social good--helping improve the long-term finances of a new generation of investors by not forcing a divide between their financial and social or environmental goals.”

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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