What is ESG Investing?

What is ESG Investing?
Environmental, Social and Governance (ESG) investing is a way for investors to diversify their portfolios with responsible and sustainable investments. Think of ESG investing as a way to build an “ethical” portfolio through socially responsible investments.

ESG investing makes the world a better place. Kumbaya and all that stuff. Stakeholders include workers, communities, customers, shareholders and the environment.

Examples of important investment trends, that focus on ESG initiatives, include the following:
1. Sustainable investing and investment management
2. Climate change in the investment process
3. Inclusion and diversity in finance

ESG investing uses a variety of non-financial factors to measure a company’s sustainability, as well as the way the company treats its people and serves its customers. On the environmental front, factors include conservation, preservation, and mitigating climate and global change. Social and governance factors focus on how a company is run by both its board, management, and shareholders.

Investors continue to incorporate ESG data into the investment process to gain a fuller understanding of the companies in which they invest.

Here’s a list of ESG factors as identified by the CFA:

Source: CFA Institute

There exist several institutions that are working to form standards to facilitate incorporation of these factors into the investment process: Sustainability Accounting Standards Board (SASB), the Global Reporting Initiative (GRI), and the Task Force on Climate-related Financial Disclosures (TCFD).

ESG and Financial Reporting

ESG metrics are not commonly part of mandatory financial reporting. However, more companies continue to disclose their ESG activities in annual reports.

ESG Metrics and Data
As of today, there are no standardized approaches to the calculation of different ESG metrics. There are, however, a variety of approaches and data sources available to investors. As an investor, there is merit to understanding the limitation of these different metrics, as well as ESG risks and opportunities.

According to the CFA Institute, analysis and data on ESG factors are critical at three points in the investment ecosystem:
1. Company reporting
2. Investor analysis and decisions
3. Investor reporting

Independent ratings are designed to assess a company’s behavior and policies. Investors get a more holistic view of the companies they study by taking into account these ratings. Investors can use the ratings to help mitigate risk and identify investment opportunities. Bloomberg, S&P Dow Jones Indices, JUST Capital, MSCI and Refinitiv are the most well-regarded research companies. Scores tend to follow a 100-point scale: The higher the score, the better a company is performing. Scores vary among firms, which employ different metrics and weighting scales. While the factors assessed vary by company, firms commonly review things like annual reports, corporate sustainability measures, resource/employee/financial management, board structure and compensation and even controversial weapons screenings.

ESG Investing is Growing
US assets under management (AUM) using ESG strategies is now over $37 trillion. And Bloomberg estimates that it may hit $53 trillion by 2025. This would represent more than a third of the $140 trillion total AUM market. The growth is largely fueled by the pandemic and the green recovery in the US. Europe accounts for half of global ESG assets. But the next wave of growth could come from Asia (Japan).

Source: Bloomberg
Source: Bloomberg

When you take a step back, you can see that the definition of ESG investing, and ESG investments, likely casts a wide net.  In other words, if more than 30% of stocks and other assets represent ESG opportunities, those opportunities are likely to cover a wide range of companies – some more ESG-focused than others.

ESG versus Socially Responsible Investing
ESG investing uses a variety of criteria to grade investments – this should help the investor clarify what ESG truly represents. Further, ESG encompasses three specific categories, as the name implies – environmental, social and governance.

Socially Responsible Investing (SRI) is slightly different. SRI focuses on impact investing on more general terms. But it tends to measure investments based on ESG-based grading. In general, SRI has acted on an exclusionary principal whereas ESG has also included companies deemed to create a positive impact. What this means is SRI funds may exclude investments like tobacco, alcohol, gambling, etc., while ESG funds also exclude them, but specifically invest in additional companies that create a positive impact.

The terms SRI and ESG tend to be used interchangeably, but they are different. It is, therefore, important to investigate the methodology used by fund managers when creating a portfolio. Values differ from one individual to the next, so take the time to identify the values most important to you and see if any fall outside of what “ESG” entails. If they do, make sure you’re looking for investments that incorporate those ideals.

Are there benefits to ESG investing?
As a retail investor, the main reason to choose ESG investing is because you desire your investment choices to be aligned with your moral and ethical priorities. For example, many investors are concerned about environmental and social problems, such as climate change leading to more and severe climate crises, gender and racial inequality, data security and privacy. They do not want to invest in firms that contribute to these problems and would rather invest in those that are leading ESG movementsHigher Returns: The jury is yet to render a decision on a “higher returns” basis for investing in ESG. Studies have shown mixed results – i.e., ESG investments don’t necessarily outperform conventional ones. One can conclude that sustainable mutual and exchange traded funds should, on average, perform similarly to traditional investments, all else being equal.

The argument can be made, however, that companies whose management are more focused on ESG initiatives in general are better managed than their non-ESG peers. I actually buy into this theory. JUST U.S. Large Cap Diversified Index (JULCD), an index that tracks the performance of large, public companies with high ESG scores. It includes 50% of the large-cap public companies in the Russell 1000 index but excludes companies that lack a demonstrated commitment to things like the well-being of their employees, beneficial products, positive environment performance and strong communities.

JULCD has outperformed the Russell 1000 for much of the period between 2017 and 2021.

Source: JUST U.S. Large Cap Diversified Index (JULCD)

It should be noted, though, that while many ESG indexes and index funds have outperformed broad indexes, they’ve done this in part because of the higher percentage of tech companies they contain.

Lower Risk: Morgan Stanley performed a study in 2019 that compared the performance of sustainable investments to traditional ones from 2004 to 2018. The analysis found that during market periods of high volatility, such as in 2008, 2009, 2015, and 2018 that traditional funds exhibited significantly larger downside deviation.

How to find profitable ESG Investments
Thereare dozens of ESG funds to choose from. The fund that I most recommend investing in is the Vanguard FTSE Social Index Fund (VFTAX). The fund maintains one of the lowest expense ratios in the industry (0.14%). The Vanguard FTSE Social Index Fund tracks the FTSE4Good US Select Index. This index excludes companies dealing in what vice products (adult entertainment, alcohol, gambling, tobacco), non-renewable energy (nuclear power, fossil fuels) and weapons (civilian firearms, controversial military weapons, conventional military weapons). The index also excludes companies based on “controversial conduct and diversity practices.”

With a minimum investment of $3,000. It’s also one of the best performing.

I also recommend the iShares MSCI USA ESG Select ETF (SUSA).

ESG Roboadvisors
There are a variety of roboadvisors that offer ESG portfolios. Several that I recommend, include Betterment, Ellevest, and Wealthsimple. There are also a several roboadvisors that focus exclusively on the ESG space, including: Sustainfolio, Earthfolio and OpenInvest.

Risks of ESG Investing
1. Lack of universal ESG standards. As aforementioned, there are no agreed-upon ESG performance standards. This creased inconsistencies across portfolios and funds. Again, do your research and make sure that the investments align with your values.

2. No long-term data on the financial performance of ESG companies. There is a lack of long-term research and tech stocks have lifted returns of the ESG sector.


CFA Institute



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iShares MSCI USA ESG Select ETF (SUSA)

Just Capital

Morgan Stanley Institute for Sustainable Investing

Vanguard FTSE Social Index Fund (VFTAX)

#esgreporting #esginvesting #esgdata #esgintegration #esgrisk

I am/we are long STOCK VFTAX either through stock ownership, options, or other derivatives. 

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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Every investor’s situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including a detailed review of the companies’ SEC filings. Any opinions or estimates constitute the author’s best judgment as of the date of publication and are subject to change without notice.

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