Diving into ESG Investing
ESG investing has become mainstream, as many people view it as a way to express their values in another area of their life. Money has impact, and making a statement with what you choose to support – and what you don’t – can be a powerful way to put your savings to work.
Environmental, Social, and Governance represent the three pillars of socially responsible investing. If you drill down, you will find 30 to 40 themes that run through the prism of ESG. Climate change, social justice, and income inequality are but a few examples.
As you start to think about retirement, and your investments will take on the role of supporting you, how do you combine a need for positive, competitive returns with a desire to have your investments aligned with your values?
If you are not an investment professional, how do you know which companies to invest in? Do “one size fits all” mutual funds really reflect your concerns? How do you know they are having any impact at all?
These concerns can be summed up as follows:
Do you have to accept lower returns if you want to invest in a socially responsible manner?
No two people will have the exact same priorities. If a fund puts ESG in the title is that enough?
How do you measure the impact that your investments are having?
Let's look at these one at a time;
Do you have to accept lower returns if you want to invest in a socially responsible manner?
A recent article in the CFA Journal says:
“One finding likely to be of interest to investment professionals is that ESG investment strategies… are generally expected to have a markedly positive impact on financial returns. This might explain why a large majority of their peers are using ESG data, even if they are not motivated primarily by ethical responsibility.” (“ESG Investing Moves to the Mainstream”)
In other words, it doesn't matter if you are motivated by your values” or if you are just seeking value from your investments, including ESG in your analysis leads to fundamentally better investment decisions.
No two people will have the exact same priorities. If a fund puts ESG in the title is that enough?
If we look again at the idea that there are 30 to 40 themes contained within the headline ESG, it seems that it would be impossible for one size to fit all. One person may be totally consumed by income inequality while another might believe that climate change is the ultimate problem facing mankind. Still others don’t want to support the military industrial complex or invest in companies that build private prisons or provide the infrastructure for detaining immigrants at the border. Gender equity, access to clean water, forced labor, the list goes on.
Every company that offers investments like mutual funds or ETFs now has some level of ESG to offer. Some, such as religious groups, have their roots in the earliest days of social investing. Some came on board during the Vietnam war and others started as opposition to apartheid. Many have only reluctantly started to pay attention, as they saw fund inflows dramatically increase for ESG funds and the writing on the wall became clearer.
There are several layers to ESG. You can screen out the bad, screen in the good or attempt to change corporate behavior with shareholder activism. Some organizations focus on the community level, trying to have a positive impact in the communities where they live and work.
As an individual investor you can buy funds or ETFs that focus on a theme, like climate change,or ones that exclude firearms, alcohol and tobacco. You can buy index funds that screen out most of the things you don’t want and still give you the advantage of passive investing.
You can use a strategy like Direct Indexing where you buy a representative selection of individual stocks that tracks the index. This gives you ultimate control to pick and choose what you want to invest in, and it gives you the tax benefits of owning individual stocks.
How do you measure the impact that your investments are having?
Whatever method you choose, you need to know if it is working. The rush to provide ESG solutions has created a new phenomenon, greenwashing. Greenwashing is the practice of putting an essentially meaningless veneer of social responsibility on the same old toxic garbage and getting a good ESG score. Recent scandals involving a large European investment firm and ongoing reports of bogus carbon credits illustrate the need for clarity in defining progress towards ESG goals. (“Carbon Offsets are a Scam'') (Greenberg)
There are several sources for evaluating companies and how well they adhere to various ESG principles. Some are independent, some are affiliated with large financial custodians. Some are very respectable-looking institutions that are actually funded by the financial services industry. As always, the devil is in the details. It takes a little more digging to find and understand the methodology that each of these organizations employ. Do they get their information from annual reports, quotes from management or the company’s social media? This self reported data is often unreliable. Another way is to rely only on government statistics and credible NGO reports to evaluate the impact that various companies are having on the things that you care about.
ESG investing can be rewarding, both financially and from the standpoint of your values. The saying goes “do well by doing good.”However, it is not one size fits all. It requires a little more work.
