ESG Investing is becoming more mainstream, but it can still seem intimidating if you’re new to the space. For those who are interested in ESG investing, but don’t know where to start, this guide will help get you on the right path toward ethical investing. We’ll go over what exactly ESG investing entails, some of the benefits of incorporating ESG into your investment strategy, and how to get started with it in both your personal and business life.
The term ESG or environmental, social, and governance is a way of describing a category of investment that goes beyond just financial performance. ESG investing is about doing well for both people and our planet. Sustainable investing means considering not only a company’s fundamental business factors like price-to-earnings ratios, earnings growth rates, and cash flow but also its impact on society: how it treats employees, interacts with community members/citizens, what kind of effect it has on the local environment and how it deals with its waste material. Combining all these factors allow investors to make socially responsible choices in their portfolios.
What is ESG investing?
Many people first learn about ESG investing through what’s called impact investing. Impact investing is a subset of ESG investing in which investors make decisions with both financial gain and social or environmental impact in mind. As opposed to socially responsible investing, which typically looks at how a company treats its employees or community-wise purposes like preventing damage from natural disasters, impact investors look for ways to profit from companies that are actively working toward positive social change.
For example, an impact investor might invest in solar energy systems because they can generate profits while helping fight climate change.
Why It Matters?
There’s little doubt that ESG investing has become much more mainstream in recent years. In fact, over 40% of institutional investors surveyed by NEPC say they use ESG strategies as part of their portfolios. But there are still plenty of misconceptions about how you can effectively incorporate these factors into your investment strategy. Whether you are looking for a way to reduce your risk or want to consider opportunities outside of stocks and bonds, consider trying out ESG strategies for yourself—it could be just what you need to meet your financial goals.
In order to figure out if ESG investing is right for you, it’s important that you have a good understanding of how these strategies can affect your investments. The goal of an ESG investment strategy is usually to balance potential financial returns with sustainability and social factors.
For example, companies that are rated higher in terms of ESG metrics are more likely to have strong financial performance in areas like growth or profitability than lower-rated companies. But perhaps most importantly, there’s also evidence that certain ESG strategies can help reduce portfolio risk by minimizing exposure to negative externalities such as corporate malfeasance or fraud risks.
Benefits of ESG investing
With ESG, you can consider both financial and non-financial factors when deciding what companies to invest in. This can help your portfolio perform better over time by diversifying away from just focusing on financial performance.
Gaining The Competitive Edge Through ESG Investing
A lot of companies talk about corporate social responsibility these days. But when it comes down to it, those that put their money where their mouth tend to stand out from their peers in a competitive market. That’s because ESG investing makes sense from both a business and an investment perspective. The businesses that really excel in sustainability offer great products or services at competitive prices—plus they make a positive difference in society while earning returns for shareholders. These firms are usually leaders on Wall Street too because they set higher benchmarks for performance than other businesses do. It’s not surprising then that ESG funds have been outperforming traditional indices by more than 3 percent each year over time —and some studies show even greater returns for companies with strong environmental, social, and governance profiles.
As more investors learn about ESG investing’s positive impact on society and its ability to return higher returns than traditional investments, many will begin to seek out companies that have demonstrated responsible behavior. Indeed, data suggest that responsible investing is becoming mainstream.
A Morningstar survey of 100 retail investors found that 91% believe it’s important for mutual funds or ETFs to invest in companies with good environmental practices—and 68% say such investments are very important. Only 15% say ESG investments aren’t worth their time or money. Two-thirds of surveyed investors said they’ve held a portfolio with environmental, social, or governance characteristics. And half of those respondents said they invested in funds offering those kinds of sustainable strategies within a year before taking part in Morningstar’s survey.
According to Morningstar, ESG funds have outperformed their peers by nearly a full percentage point on average each year over the past decade. At some fund companies, such as Vanguard and Parnassus Investments—the owner of Zevin Asset Management—more than half of all money invested has been in ESGs. As these alternatives become more mainstream investments—and attract more of our attention with strategies that emphasize better corporate governance or environment practices—there’s a good chance they’ll continue doing so. In other words: your sustainable investments may also turn out to be very profitable ones!
It’s widely agreed that ESG investing lowers overall portfolio risk. Studies have shown that ESG portfolios outperform comparable traditional investments by an average of 1.5% per year, which amounts to a significant difference over long time periods. What’s more, most standard investment strategies aren’t factoring in environmental or social factors; so while they may be lowering their exposure to high-risk assets like tobacco or pornography companies, they are increasing their exposure to other high-risk investments like subprime mortgages or credit derivatives in unregulated markets. By incorporating environmental and social factors into your investment strategy you can reduce your overall portfolio risk while remaining diversified.
For example, investors who added ESG factors in 2007 would have seen their portfolio’s assets fall by only 9% compared to 16% for traditional portfolios. This is because more than 80% of investments tied to subprime mortgages were held by traditional portfolios. Including factors like those tied to ecological impacts and labor standards would likely have reduced overall portfolio losses even further. If you had started investing in 2005 with a traditional portfolio but included ESG factors, your returns would have been 12% per year versus 5% for a standard investment strategy.
ESG vs. Socially Responsible Investing vs. CSR
In recent years, socially responsible investing has garnered a lot of attention for its attempts to integrate social or environmental goals into financial decisions. Socially responsible investing can include a variety of strategies including those that limit fossil fuel investments or target specific companies for political reasons. The oldest form of socially conscious investing is ESG investing – Environmental, Social, and Governance. This approach targets companies with good governance practices as well as a long-term view of how they impact their communities. So what’s different between socially responsible investing vs ESG? Simply put, it’s more holistic in nature than merely targeting certain industries or corporate behavior while also limiting exposure to outside factors such as governments and environmental policies.
ESG investing is concerned with the governance practices of companies rather than with social or environmental goals alone. For example, you could look at how a company manages its carbon footprint across its supply chain. That’s an impactful factor for measuring the ESG performance of an oil or gas producer that produces energy from fossil fuels as well as solar panels. However, it’s also easy to manipulate that data by overstating your contributions when you don’t take into account external factors such as policies being put in place by local governments that may affect your bottom line.
While you can find out a lot about companies by digging into their corporate social responsibility reports or corporate governance ratings, ESG investment managers analyze them in much more depth. They look at factors like gender diversity in a company’s leadership team, sustainability efforts such as green energy initiatives, and whether they are signing new contracts that could increase exposure to political risk abroad. The next question is how do you get started with ESG investing? It’s simple actually – many of these companies offer mutual funds where you can participate without having your own investment portfolio. Another option is an index-based exchange-traded fund that tracks an index based on ESG factors rather than just focusing on financials or volatility.
Why Should You Choose ESG Investing?
There are many reasons why investors choose ESG investments over other investment options. The most commonly cited reason is that they believe it’s simply a more sustainable way of making money. After all, investing in businesses with poor environmental or social records can lead to corporate scandals down the road and even legal repercussions for executives. ESG investing also gives investors more control over where their money goes; for example, if you have ethical objections against investing in firearms manufacturers or fossil fuels companies (as some do), then an ESG strategy allows you to only make investments in those companies that align with your personal values.
Although it’s good for moral reasons, ESG investing is also a smart financial strategy. Some studies have found that ESG-aligned businesses actually outperform non-aligned companies in terms of share price growth over long periods of time. This could be because investors are getting higher yields with ESG companies or simply because these shares rise in value as other investors become aware of ESGs’ impressive performance records. Whichever reason you choose to invest in an ESG company over another investment option, however, doing so can increase your chances of making better returns on your money down the road.
How Can You Find ESG Investments?
If you are ready to put your money to work in an ESG strategy, there are a variety of methods to find investments that meet the criteria, including doing research on your own, using Robo-advisors, or consulting with a financial advisor. If you are ready to do so, read on.
Do Your Own ESG Research
Before you invest in a company, you should make sure you know about its environmental and social impact—and that includes holding a company accountable for any unethical business practices. However, it’s hard to know how ethical or socially conscious every company is when there are thousands out there. To streamline your research process and make it more targeted, check out websites like The Motley Fool’s website, which provide information on ESG scores alongside stock ratings. By doing your own research into ESGs before investing in a company, you can confidently rest assured that your money will be spent well. Companies aren’t transparent with their ESG scores because they want your money; they’re transparent because they care about their bottom line.
ESG factors are increasingly being included in some Robo-advisor portfolios. The biggest, best-known players all offer ESG funds or funds that are screened for ESG traits: Vanguard offers both, as does Betterment. Wealthfront’s newly launched sustainable ETF gives access to an index of clean energy stocks and a U.S. large-cap fund with strong green ratings from Morningstar. If you’re just getting started, these are good places to start — but it pays to do your homework since not all ESGs are created equal. To learn more about how ethical investing might be right for you—and what a modern Robo advisor can do for you—check out our full guide here.
ESG Financial Advisors
When you’re ready to invest in an ESG strategy, it’s a good idea to work with an expert. A financial advisor can help you find investments that align with your values and can also help you navigate the complex world of ESG investing. An advisor can also help you find specific investments—such as a socially responsible mutual fund or a clean energy ETF—that align with your goals and values. An advisor can also help you find a financial advisor who specializes in ESG investing and will work with you to build an ESG portfolio.
Where To Start With Your ESG Journey
There are two main questions you need to ask yourself before investing in ESG funds: Do I want a more socially conscious portfolio? Does my investment manager offer these funds? If yes to both, you can move on. Otherwise, your next step is probably a trip to your company’s HR department or other people in charge of your benefits. You’ll have some explaining ahead of you—after all, some people have negative associations with investing for good because they had bad experiences with charity fundraisers or lost money on social causes that promised big but failed. That said, it’s time we rethink our approach toward ESG investing. We shouldn’t be scared of taking risks when they come hand-in-hand with massive rewards.
Other Strategies for Socially Conscious Investing
Before you invest, you must decide which ESG factors are most important to you. Do you care most about reducing your carbon footprint, ensuring fair treatment of workers, and protecting working conditions? Or do you just want a higher return? You may find that one factor or a few factors are most important to you.
Socially Responsible Investing (SRI)
It is an investment style that attempts to reduce a company’s environmental impact by purchasing shares in companies that have taken steps to reduce their environmental impact, such as adopting a corporate sustainability policy or certifying their sustainable practices. SRI investment funds seek to balance the risks and potential rewards of investing in companies with a strong ESG profile, while still delivering a high return.
The emphasis of impact investment is less on financial rewards and more on the social or environmental goals being pursued. Through the practice of impact investing, investors put their money into businesses that are working to find solutions to critical issues all across the world. These industries may include those that are making strides toward more environmentally friendly and renewable forms of energy, housing equity, affordable healthcare access, and other areas.
A common concern among ESG investors is that the funds they invest in aren’t diverse enough, which could put them at greater risk of concentrated losses in a single industry. However, there are many ESG-focused investment opportunities available, and, if carefully selected, these can provide good diversification.