How to Get Started in ESG Investing
More and More Investors are Aligning Their Dollars with Their Values
2021 has arrived, and with it, the fresh start to a new year. It is a good time to rethink the investment landscape and take a closer look at avenues you may not have explored in years past. One investment strategy that has proven to have staying power in the last year is ESG, which stands for Environmental, Social, and Governance investing. This strategy allows investors to align their values with their dollars and support companies that align with what is most meaningful to them.
There is a misconception that making an ESG investment requires you to sacrifice earnings to make an investment based on your values. Over the past year, however, we’ve seen the market affected in many ways by COVID-19 and social equality movements, and the numbers have shown that sustainable ESG investments are not limiting portfolio growth but outperforming their counterparts instead.
Understanding Sustainability and ESG
It is important to understand the subtleties of ESG investments before beginning to integrate them into your portfolio. Several investment types are similar but different.
Socially Responsible Investing (SRI) – SRI investments avoid specific assets considered by the investor to be socially irresponsible. Investments from that company or asset type are removed or not considered for the portfolio. An example of this would be something like a tobacco company or a company that has a poor environmental record.
Impact Investing – Impact investing is when you put your money towards a company in which you can see the impact of your contribution. This is favored by investors who like to know where their money is going and what it is being used for. Impact investing can be seen in the purchase of bonds to fund specific projects.
Environmental, Social, and Governance Investing (ESG) – ESG investing is the most complex of the three. It is built on comparing classic investing criteria like valuation and earnings growth versus its sustainability concerning environmental, workforce, labor, and social issues.
To be more specific about the ESG criteria, ESGs are companies that approach these categories (environment, workforce, labor, etc.) with long-term sustainability in mind. ESG companies will be the ones who are targeting energy efficiency, renewable energy, and pollution. They also focus on long-term social goals such as creating a diverse workforce, having fair wages, and supporting local communities. Governance is addressed by regulating executive salaries, political donations, corruption, and including boards who are more involved in the long-term sustainability of the company. ESG investing is not targeting ideologies directly. It is targeting the practices that help a company weather storms over the long-term by contributing to the greater good.
SEE ALSO: Lessons in Behavioral Investing
Overcoming ESG Myths: Reviewing 2020 and Looking Forward
A roadblock for many investors interested in ESG investing is finding a financial advisor who supports this investing strategy. Unfortunately, many advisors believe the myth that ESG funds don’t perform as well as more traditional funds. If ESG investing is important to you, you’ll want to interview multiple financial advisors and ask them pointedly about their feelings on ESG investing. Even if they express positive views, you should still determine whether they are knowledgeable about this type of investing.
Looking at the numbers over the past year, we have seen that a focus on sustainability has paid off for investors who have begun to integrate ESG assets into their portfolios. These companies in question often use fewer resources, are exposed to less risk, and are generally run more efficiently. Though they were still deeply affected by the pandemic, the funds demonstrated greater fortitude than others. A study from last April showed that sustainable funds outperformed, with seven of ten sustainable equity funds finishing in the top half of their category, and twenty-four of twenty-six ESGs outperforming their traditional equivalents.
This resilience is not simply a one-time occurrence either. In the third quarter of 2020, we saw another increase in ESGs, and the flow in funds shot up from $21.4 billion in 2019 to $30.7 billion in 2020. The growing popularity of ESGs is, indeed, solidifying after a year that challenged portfolios across the board. So, if you’re ready to begin ESG investing, be sure you find the right financial advisor to partner with.
Knowing What You’re Getting: Determining Your ESG Methodology
With the outperformance of ESG investments, it is increasingly becoming a buzz word. It is beginning to trend toward becoming a standard of assets, and more and more companies and funds are given the moniker of being an ESG fund. As this trend increases, it’s important to keep a discerning eye out for those that are actual ESG funds and those that aren’t quite aligned with your values after all. There are tools available to help, like Morningstar’s Sustainalytics, which ranks and categorizes the risk of companies on the ESG spectrum.
Because ESGs are not a fund unto themselves but, rather, folded into investment funds, it may be more challenging to find the right balance. Reaching out to a financial advisor or asset manager is a good step toward parsing what will be a good match for your portfolio. Once you’re on the same page with a financial professional, you and your advisor can begin getting specific about how you’ll measure potential investments to determine whether they’re the right fit for you. Let’s say, for example, you’re an ESG investor interested in companies with strong gender equality policies. You and your advisor may want to utilize one or more of the many companies that offer values-based investment research. Popular options include Calvert, MSCI, As You Sow, OpenInvest, YourStake, and Morningstar’s Sustainability Ratings. These sources allow you to screen potential investments and see their “grades” in specific areas.
Final Thoughts on ESG: A New Market Place, A New Investor
In addition to the marketplace beginning to show increasing success with ESGs, we are seeing an increase in the power that women and millennials have on the marketplace. The increase of women-owned businesses and women on the boards of companies grant a stronger voice in the economy. Millennials, on the other hand, are on the precipice of inheriting one of the biggest transfers of money in United States history in addition to coming into their own as a generation financially. With both women and millennials tending to emphasize sustainability in their portfolios more so than previous generations, the result will be even more dollars flowing into ESG investments in the near future.