ESG stands for Environmental, Social and Governance. ESG investing entails looking at companies and funds that invest based on one or more of these principles.
How ESG investing differs from ordinary investing
ESG represents non-financial factors that investors use to measure a company’s or a fund’s level of sustainability. Environmental refers to the company’s business practices relating to the environment, social refers to how the company treats those both inside the company and outside and governance refers to how the company is run in terms of shareholder voting and other factors.
Many say that ESG is the next step along the investing spectrum from SRI or Socially Responsible Investing. SRI does take into account the social and environmental aspects of a company or a fund. SRI also actively avoids investments in companies that investors feel don’t meet their criteria as being socially responsible. Examples might be tobacco companies or those producing alcoholic beverages.
Some say SRI is more about activist investing while ESG investing focuses on how a company’s adherence or lack thereof to ESG factors impacts the bottom line.
There are several companies that calculate ESG scores and all do so in slightly different ways. They are designed to show how well or poorly a company’s performance regarding applicable ESG metrics ranks compared to other companies. Looking at ESG scores can provide investors with a quick way to compare ESG performance, but it is just a starting point.
Investors who focus on ESG metrics will tend to take this into account when screening potential investment candidates.
Types of ESG investing
ESG stocks represent companies who score high on the various ESG factors. Besides having high sustainability ratings, companies that score high on ESG factors often tend to be well run and profitable. For example, a company that scores high in the environmental factor will likely not be faced with government levied fines or penalties for polluting the environment.
ESG funds invest in companies that tend to score well on one or all of the ESG factors. The fund managers use ESG as one of their screening criteria in choosing stocks to hold in the fund.
The Future of ESG Investing
To date, companies and funds with high ESG scores have performed well in terms of their returns. Morningstar data has shown that ESG funds have demonstrated lower volatility and solid returns on equity. Many of these funds have shown above average longevity as well.
Investors want more transparency to back up the ESG claims of companies and fund managers. The practice of greenwashing has come under fire, this refers to making unsubstantiated claims about a company’s or a fund’s adherence to ESG factors.
ESG 2.0 is about greater ESG transparency. The use of technologies such as blockchain can help in storing ESG related data and making this data more accessible to investment advisors. This will enable advisors to use this data to discuss the impact of investing decisions regarding sustainability issues with their clients.
Regulators are also making the accurate disclosure of ESG data a higher priority. The SEC is expected to increase their disclosure requirements on issues like carbon emissions and to delve more into money manager’s ESG classifications for the stocks in their fund’s portfolios. They are concerned that investors have accurate ESG data upon which to base their investing decisions.
Increased regulatory scrutiny combined with housing ESG information on blockchain and other databases will provide investors with greater accessibility to ESG information upon which they can base their investing decisions.
Incorporating ESG into your portfolio
There are a number of ways to incorporate ESG investing into your portfolio. Regardless of how you proceed here, it’s still important to do this within the context of your asset allocation and overall investing strategy. ESG investing is more than just a passing fad, it has become a mainstream investing strategy.
ESG mutual funds are one way to do this, individual stocks adhering to ESG principles are another. Perhaps the best solution for investors who are interested in incorporating ESG friendly investments into their portfolio is to discuss this issue with their financial advisor.
If you are interested in ESG investing as part of your strategy, contact your Wedbush financial advisor to discuss the best way to incorporate ESG investments into your strategy.
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