Are you concerned about climate change? Do you think companies should do a better job at having a positive impact on the environment and society? I have good news! Your money can make a difference while you build wealth. Welcome to ESG Investing.
There is a new buzz in the investment world called “ESG Investing.” What is it? ESG is the financial industry term but there are numerous terms for it; impact investing, sustainable investing, socially responsible investing (SRI), green investing, etc. With ESG, investing companies are screened to meet 3 factors – Environmental Social, and Governance. Let me break these down for you:
Environmental
The impact that companies have on the environment. Examples are reducing emissions and climate impact, using renewable energy, limiting pollution, eliminating the use of hazardous or toxic materials, and limiting waste by using less packing materials.
Social
The Impact companies have on society. Examples are product safety & quality, positive community relations, chemical safety, health & safety, social opportunities such as access to healthcare.
Governance
The impact companies have by the way they operate. Examples are board diversity (making sure there is equal representation across gender, race, and ethnicity on the Board of Directors), executive pay, business ethics – corruption and instability, tax transparency.
Here are the screens from Vanguard’s white paper that they use on their ESG funds:
Once these companies are screened and approved, they are allowed into the fund. These fund managers build mutual funds like your typical investments but with ESG screened companies. Some funds focus on specific areas such as SHE ETF, which only invests in companies that have strong women leadership or ETHO ETF where its primary focus is companies that create small carbon footprints.
The good news is this type of investing is growing in popularity! Funds flowing into ESG more than DOUBLED from 2019 to 2020 at a rate of 206%. And so far, this year we are on track for a record year of inflows into ESG. BlackRock’s head of iShares Americas, Armando Senra, thinks ESG investments could hit $1 TRILLION by 2030!
Beware of the Performance Myth
And yet, there is a myth out there that the performance (returns) on ESG investing are not as good as typical investing, but the data shows otherwise. You can still do good through ESG investing and not compromise returns. A picture is worth a thousand words, so I’ll leave you with a study Impax Asset Management did on ESG returns. Hint: Blue bars are ESG returns.
Less Risk
Companies that meet ESG standards are normally less risky than those that do not. In fact, companies that don’t consider ESG are more likely to have huge financial losses. Take BP with their big oil spill. Also, data is showing they are actually less volatile during market downturns.
Where can you invest in ESG and have portfolios made for you
*Note: There are fees at these institutions so please ensure you check out their pricing before opening an account.
Vanguard is one of my favorite institutions, but sadly at the date of this post, they still don’t have an easy model for you to invest in. If you are at Vanguard, there are 2 ESG ETFs and a few social funds, but you need to have knowledge around building a portfolio (or have me on your team 😀 ) to ensure that you are properly diversified before going this route. If you are planning to make a portfolio yourself, don’t be overly concentrated in one industry or asset class. You still need to diversify i.e. have US, international, small vs. large companies, fixed income (bonds).
Important Notes & Warnings that come with ESG
ESG is not perfect. There is not a standardized rating system in our industry of how funds are screening and scoring companies for the ESG factors. Some may be more strict than others and you may be surprised by the companies that make the cut. For example, Amazon is one of the largest holdings in some of these ESG funds because they have reduced their packaging waste, improved warehouse labor conditions, and say they will use 100% renewable energy by 2030. Based on the criteria, they score high enough to make the cut. Also, fund fees (ETFs or mutual funds) can be higher than typical investments because the fund managers have to screen the companies (which takes time).
My Ask of Our Industry
We need to have more options for investors – especially models/target-date funds that are ESG. Come on, Vanguard!
There needs to be a standard and clear scoring system so investors and financial planners can easily see which ESG criteria have been met, how strict the fund manager was on the screening, etc.
My Closing Thoughts
The more money that flows into ESG, the stronger the message to corporations is that investors care about the impact they have on society. Money is powerful. I only expect ESG investing to continue to grow, meaning corporations will be forced to improve their sustainability efforts if they want your money. Sure, the screening process isn’t perfect, but the more money that flows into ESG investing, the more the financial industry and fund managers will have to pay attention, offering clearer standardized screens and even better ESG investment options.
If the ESG criteria mentioned above is important to you, then look into ESG. For my clients that are concerned about society and the environment, ESG has been a great option. At TF, I’m able to build my clients a diversified portfolio without compromising on returns. In return, they have a better relationship with their money knowing it’s going to ESG investments. They feel good about growing wealth when their investments are aligned with their goals and values. What could be better than that? That is a powerful relationship. Money for good.
Disclaimer: This is not investment advice and I am not recommending any specific investments. Investments entirely depend on your personal financial situation and I highly recommend you seek out advice. Also, note there are still the same risks that come with investing when you invest with ESG. Your portfolio will still be volatile and go up and down. This comes with investing. Returns can be different and fund expenses are normally a little higher because the fund managers have to screen out the companies, but for most of my clients, their values strongly outweigh those items.
* US SIF Report on US Sustainable, Responsible, and Impact Investing Trends 2018; The Forum for Sustainable and Responsible Investment (US SIF) works to advance investment practices that consider Environmental, Social and Corporate Governance criteria to generate long-term competitive financial returns and positive societal impact.
