One of the biggest buzzwords lately in investing isn’t even a word; it’s an acronym: ESG.
ESG stands for Environmental, Social, and Governance, and the concept has become increasingly prominent in recent years.
How is ESG investing different?
The concept of ESG investing has many names. Some you may have heard are sustainable investing or responsible investing. These terms all refer to the idea of investing according to your morals or ethics.
One simple way to achieve this is to use a positive or negative screen when selecting investments. A positive screen might lead you to invest only in companies with well-documented green business practices. A negative screen may exclude any companies that use Chinese sweatshops from your portfolio.
Here is a list of common ESG themes:
|Animal welfare||Child labor||Shareholder rights|
|Climate change||Human rights||Political lobbying|
|Deforestation||Employee relations||Executive compensation|
|Renewable resources||Diversity and inclusion||Corporate risk management|
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Why consider ESG investing?
If you are like many people, it probably just feels good when your investments align with your convictions. As a result, you may find you sleep better at night.
Investing in companies whose business practices you consider ethical also rewards them. In theory, providing capital can help them develop and grow. Likewise, avoiding companies that don’t align with your values can “punish” them.
But what about your bottom line? After all, when we invest, our goal is to make money. Moreover, there’s a growing amount of research that supports ESG from a performance standpoint. For example, Morningstar released a study earlier in 2019 that showed that 73% of the firm’s ESG stock indexes outperformed non-ESG equivalents since inception. For many investors, combining values-based investing and outperformance is a no-brainer.
Are there any downsides to ESG investing?
Most ESG funds are actively managed. This means you have to pay a portfolio manager to choose which companies to buy (and if or when to sell them) in the fund. Unlike passive funds, which track the performance of a particular index, actively managed funds have higher fees. But there is a handful of lower-cost, passively-managed ESG investment options available.
The definition of ESG investing is a bit fuzzy. Right now, there is no universal standard for it. As a result, it can mean different things to different people.
And you have to ensure that the companies or funds in which you invest actually walk the talk. For example, some companies claim to follow ESG practices but don’t. This is called “greenwashing.” Often, this happens unintentionally, as companies are eager to get on the ESG bandwagon. But in other cases, companies purposely mislead investors about their ESG stance.
How can I get started?
ESG investing is a fast-growing but relatively new concept. If you’re interested in learning more and possibly adjusting your portfolio, a financial advisor can help you decide on the right ESG investing strategy. Get started with a no-cost, no-obligation review of your financial plan.