Socially responsible investing and investments have taken the entire world by storm. In the United States alone, mutual funds with a social investment strategy have taken in billions of dollars from investors demanding companies become sustainable and take account of their impact on society and the environment.
However, the sphere of sustainable investing operates in many grey areas. For instance, is a firm that gives to charity in one country but does damage to the environment is considered sustainable? ESG or Environmental Social and Governance investing aims to change that. In this article, we will discuss ESG investing in detail and how to get started.
What is ESG or Environmental Social and Governance investing?
ESG investing is a concept that takes into account the social and environmental impact of investments. It is based on the premise that companies have to consider social, environmental, and governance issues to become sustainable. The term is believed to have been coined by The Forum for Sustainable and Responsible Investment in the United States.
Why should you consider ESG investing?
Investing with an ESG strategy means considering the impact of a company on people and the environment in addition to financials. It can result in returns that outperform their peers by reducing volatility and considering external factors that may affect a stock’s performance.
Most importantly, it looks at workplace diversity, supply chain management, product safety, environmental impact, etc.
How does this form of investing differ from Socially Responsible Investing?
ESG investing generally goes a step further than SRI as it considers the environment, society, and governance issues. Socially responsible investments are based on environmental, social, and governance criteria.
However, ESG investing will also take into account companies with strong governance practices, as this is believed to be a predictor of a company’s long-term success.
Unlike SRI, ESG Investing uses specific rules and criteria to grade all investments. This way, it attempts to clarify exactly what sustainable investing is. It also hopes to put pressure on companies around the world to change their ways so they can be called sustainable investments in the real essence of the word “sustainable.”
What are the benefits of ESG Investing?
Below are the top benefits of ESG investments
#1 High Returns
ESG investments have the capacity to outperform traditional investments. This was found in a 2019 white paper published by the Morgan Stanley Institute for Sustainable Investing. The research found that sustainable investors could beat the S&P 500 by 1.4% from 2014 to 2018. Leading investment bank Morgan Stanley even claims that the companies with higher ESG scores have been much better protected against the negative economic impact of the COVID 19 pandemic.
#2 Less Volatile
Whenever you are investing, reducing your risk exposure is always important. ESG investments reduce the overall volatility of your portfolio as they are less volatile than traditional investments. These companies face fewer value fluctuations due to additional and better risk filtration strategies. Negative events like mistreatment of employees, environment, or management are less likely to impact a company’s stock value.
#3 Build a portfolio as per your values
ESG investments come with the benefit of conforming to your values. This translates to a more responsible portfolio. For instance, if you are a Muslim, you may want to invest in sharia-compliant stocks. Similarly, if you are a vegan, you can invest in wildlife-friendly companies. If you care about climate change, pick a green bank that doesn’t invest your money in fossil fuels. What’s more, applying a sustainability strategy ensures you can protect yourself from all the bad actors. At the same time, you can play your part in contributing to a positive global change and a better world for your generations with your money.
ESG investments Examples
ESG investments come in several forms. You can invest in an ESG stock or a fund with a high ESG score. Below are the top 5 ESG investments in November 2021, according to Forbes:
- Vanguard FTSE Social Index Fund (VFTAX)
- iShares MSCI USA ESG Select ETF (SUSA)
- Parnassus Core Equity Investor (PRBLX)
- iShares Global Clean Energy ETF (ICLN)
- Parnassus Core Equity Investor (PRBLX)
ESG Factors
Factors that make up an ESG investment are usually interlinked. Therefore, it can be difficult to ascertain whether a factor is purely Social, Environmental, or Governance related. Sure, you can measure these factors (for instance, employee turnover for a company), but determining their monetary value (for instance, the cost of employee turnover) can be a real challenge.
Environmental Factors
Goal: Conservation of the ecosystem
- Climate Change
- Deforestation
- Pollution
- Biodiversity
- Energy efficiency
- Water management
- Water scarcity
- Waste management
Social Factors
Goal: Consideration of the people, society, and their relationships
- Basic Human Rights
- Privacy & data protection
- Customer Satisfaction
- Women Empowerment
- Diversity
- Employee Engagement
- Labor Protection
Governance Factors
Goal: Standards for running a business/company
- Whistleblowing Schemes
- Corruption
- Audit Structure
- BOD composition
- Lobbying
- Political contributions
ESG Investments: How to Start?
Thanks to the increased education about ESG investments, building an ESG portfolio is now easier than ever. There are several options to invest in. Let’s look at how you can get started without breaking a sweat.
#1 DIY or Need Help?
Do you want to do it yourself or need a helping hand?
The first thing you need to consider is whether you want to delve into ESG investments yourself or need a Robo-advisor. Robo-advisors are either paid by the management company or charge a small percentage of your assets under management.
Find Your Own ESG Investments
If you know what you’re doing, you can usually invest with little or no fees. But, you will have to do extensive research on a company’s sustainability initiatives in order to ensure they align with your goals. Alternatively, you can get a brokerage account. Some of them come with screening tools to help you choose a suitable socially responsible investment. Once that phase is done, you are en route to the next.
Need Help to make a choice
Building an ESG investment portfolio is not easy. It takes time and considerable effort on your part. Especially if you want to find investments that align with your moral compass. Robo-advisors make it easy. They help you build as well as manage ESG portfolios on the basis of your risk tolerance and investment objectives. Robo-advisors are fee-based or charge a percentage of your assets under management. However, they are considerably less expensive than in-person advisors who charge a hefty consultation fee.
#2 Know Your Policy
ESG Investments come with very clear boundaries. You need to be clear about the ESG criteria you are looking for in an investment. Remember, values can differ from one person to another. You need to take your time to identify vital values and whether the investment you are looking at incorporates these values. For instance, Muslim or Jewish investors may want to ensure that their ESG investments align with the boundaries set out by the respective religious laws.
#3 Find Your Investment
Once all the pieces are in place (You have a Robo advisor or a brokerage account), you need to find your ESG investments and start building your portfolio. A pro tip is to start reading reviews from independent research firms like Envestnet, fi360, or Morningstar to better understand how a company’s fund scores in ESG. After that, you can decide whether or not you would like to invest in their options.
Most ESG portfolios include the following three types of investments.
1. Individual stocks
Usually, it’s a good idea to limit your portfolio in individual stocks to 5-7%. You can invest in a variety of industries that align with your values. However, remember that individual stock investments come with higher volatility. If you are not an experienced investor, it’s a good idea to stay away from individual stocks.
Some companies publish impact reports that highlight cultural, social, and sustainable initiatives they have undertaken. If you can’t find impact reports on their website, you might want to contact the company’s investor relations department. Alternatively, you can also check reviews of a company on third-party websites such as Glassdoor and Indeed.
2. ESG mutual funds
Mutual Funds can be a great way to incorporate ESG investing in your portfolio. Most of the mutual funds have been around for quite some time and are backed by active managers. With mutual funds, you are not directly investing in a single stock but rather in an index of stocks that share similar characteristics.
Mutual funds are easy to get. They can fill up your holdings very easily and help you diversify your portfolio. And with the number of ESG mutual funds on the rise, it’s now all the easier to find a particular mutual fund that aligns with your moral value. Some of them focus on particular issues like green energy, water management, pollution, etc., making it all the easier to personalize your portfolio’s impact.
3. ETFs
ETFs are Exchange Traded Funds. Some consider their mutual funds. ETFs consist of a basket of stocks that follow the same strategy as the fund into which you invested. Buying ESG ETFs is simpler than buying mutual funds. You only have to buy the right stocks, not worry about management fees or trading commissions.
ETFs are not always easy to get, but there are some out there. The famous SPY (S&P 500), which you can buy in an ESG version, is called SPDR S&P 500. Similarly, there are around 20 other ETFs that have been created using ESG criteria.
Final Thoughts
ESG investing is a growing trend and is likely to take off in the coming years. A company can be successful in terms of growth, but that does not mean it is good for society. Therefore, it’s a good idea to get ahead of the pack and start investing your money wisely. We hope now you know ESG investing definition, what is ESG investing, and to get started. Thank you for reading.
Frequently Asked Questions (FAQs)
How is ESG Score calculated?
Well, the ESG score is calculated by companies using different criteria. That means there is no single authority on the ESG Score. ESG indicators can differ from company to company.
For instance, the MSCI ESG Research utilizes data from company disclosures as well as independent resources. The Dow Jones Sustainability Index, on the other hand, uses the questionnaire method to gather data from the companies.
What are some good ESG Companies right now?
The top 10 best ESG companies at the moment are Microsoft, Linde, Accenture, J.B. Hunt, Xylem, Texas Instruments, Salesforce.com, Gildan Activewear, Metropolitan Bank, and IHS Markit.
What are some good ESG funds at the moment?
According to Forbes, the top 7 ESG funds of 2021 are:
- Vanguard FTSE Social Index Fund (VFTAX)
- iShares MSCI USA ESG Select ETF (SUSA)
- Parnassus Core Equity Investor (PRBLX)
- iShares Global Clean Energy ETF (ICLN)
- Shelton Green Alpha Fund (NEXTX)
- 1919 Socially Responsive Balanced Fund (SSIAX)
- AllianceBernstein Sustainable Global Thematic Fund (ATEYX)
Is Tesla an ESG?
According to Just Capital, a top ESG research non-profit organization, Tesla ranks at the bottom 10% of all the ESG Companies in 2021. Tesla values broad social issues more than climate change specifically. Likewise, FTSE Russell ranks Tesla last among all the car manufacturers globally on the ESG investments list.
