ESG investing is a type of investment strategy that considers a company’s socially responsible operations as a factor for your investments. While the concept of investing according to your values isn’t new, the term ESG and the ways in which it’s measured are. But you can still use an ESG investment mindset when exploring and diversifying your portfolio.
What Is ESG?
“ESG,” which stands for environmental, social, and governance) was first coined in 2005, but the concept goes back much further.
“The dual mandate of doing good while also doing well was first articulated by 17th century Quakers in England,” says Haleh Moddasser, CPA, Senior Vice President and lead advisor at Stearns Financial Group. “As an investment concept, the first iteration of the dual mandate was SRI (socially responsible investing) where entire asset classes were excluded from portfolios, resulting in lower returns.”
What Is ESG Investing?
ESG investing only increased in recent years, as non-financial factors like climate change to social justice have influenced investors, according to the CFA institute. Socially responsible investors are out to prove that they can invest in companies they care about while still making money.
The first ESG-related investment launched 50 years ago and has recently gained traction.
“The first sustainable investing mutual fund launched in 1971 and it focused on the exclusion of certain companies due to ethical considerations,” says Jason Hoody, CFA and Head of Investment Manager Research at LPL Financial. “In the early 1990s, fewer than 30 companies provided ESG disclosures, whereas now over 8,000 companies are publishing disclosures.”
Take your investments to a different level by caring about each security in your portfolio with ESG investing.
ESG investing involves analyzing a particular company, stock, or other investment security based on factors that aren’t always tied to money.
Benefits of ESG Investing
When you get the chance to invest in something you truly believe in, the investment has an even greater impact. There are a few different benefits to ESG investing, according to Moddsasser.
“The investor feels better about the companies he or she invests in,” she says. “No longer does this investor have to support a company whose values contradict their own with respect to climate, equality, and transparency.”
Being an investor in a company gives you more power than you think. While consumers cause change with their dollars, investors cause change with their dollars and voices.
“Participating in shareholder resolutions and voting proxies actually promotes changes in corporate behavior,” Moddasser says. “The goal of ESG, in other words, should not be as much about punishing a company for bad behavior as promoting healthy change toward a more sustainable future.”
ESG investing helps align your investments with your values.
“Many of us consider ourselves valued-centered individuals and yet have not gone so far as to carry those values all the way through to our finances,” says Brian Haney the founder and vice president at The Haney Company. “However now more than ever we can vote with our wallets and our wall street investments.”
ESG vs. SRI vs. CSR
With so many acronyms, it’s hard to keep up on which one you want to follow. All of these are closely linked, so it’s easy to get them confused.
Environmental, Social, and Governance: ESG does not exclude entire asset classes, but rather, weights them differently depending on the goals of the portfolio.
Socially Responsible Investing: [SRI] is focused more on exclusions. By excluding entire asset classes, SRI portfolios can sometimes lag non-constrained portfolios.
Corporate Social Responsibility: CSR refers to the concept of being a good corporate citizen, while SRI and ESG are the investment mechanisms investors can use to support these ideals.
How Does a Company Meet ESG Criteria?
Even though ESG isn’t new, it’s still very new in how Wall Street regulates it.
“ESG is still a relatively new concept lacking in both standardization and regulation,” Moddasser says. “Often, corporate behavior is self-reported and “greenwashing” can occur. [This is] where companies claim to be more sustainable than they actually are to curry investor favor.”
Hoody says ESG criteria and ratings can differ from company to company, so it’s not an exact science when it comes to comparisons.
“A forecast of judgment on how much one ESG risk factor will impact a financial metric, such as future cash flow, may differ from one investor to another,” Hoody says. “Frameworks, such as materiality assessments or maps, are helpful in providing some guidance, [but] ultimately leads to a spectrum of opinions, much like traditional investing approaches. As a result, ESG ratings may differ from one provider to another.”
Since there isn’t one universal standard or approach to ESG investing, you’ll need to use any available data to make your investment decisions. Use company reporting, investor analysis, and investor reporting to analyze a company’s ESG data. This might take a little bit more time on your part as an investor, so plan accordingly.
How to Get Started Investing in ESGs
If you want to be more intentional with your investments, it’s time to put your money where your consciousness is. Start by understanding your own motivations and interests, then use the tools available to you.
“Common motivations include reducing risk, improving returns, and achieving an economic or social outcome,” among others, Hoody says. “For individual investors, it may be difficult to select individual securities due to the need to gather company-specific ESG information. [Investors may] need an intermediary financial product such as a mutual fund or ETF.”
Hoody suggests looking at the US SIF list as a good starting point. It’s also a good idea to start small; you don’t need to overhaul your entire portfolio overnight.
“Finding a strategy or two, becoming more aware of various approaches, and slowly increasing your portfolio’s exposure to sustainable investing is a common way to get started,” Hoody says.
If you’re looking for help, Moddasser says to find a financial firm that specializes in ESG.
“Many financial advisors are resistant to ESG portfolios, in spite of their recent surge, and frankly are not well educated on them,” she says. “Find an advisory firm that has ESG knowledge and an ESG platform. [Specifically] one that is a fiduciary.”