ESG Investing is Here to Stay
“At its core, ESG investing is about influencing positive changes in society by being a better investor,” says Hank Smith, Head of Investment Strategy at The Haverford Trust Company.
ESG investing is an investment philosophy within the responsible investing realm. Socially responsible investing began in the 1960s, with investors excluding stocks or entire industries from their portfolios based on unconscionable conduct. Coined in 2004, ESG stands for environmental, social and governance.
Environmental: The environmental component considers a company’s impact on the planet. ESG investors may question how a company mitigates its greenhouse gas emissions, the sustainability of the company’s products, how the company uses renewable energy and its recycling efforts.
Social: The social component considers people-related issues, like company culture and factors that impact employees, customers, supplies and the community. Some considerations include employee treatment and pay, diversity and equal employment opportunities in hiring, ethical supply chain sourcing and public stance on social justice issues.
Governance: Governance (or corporate governance) refers to the strength of the board of directors and company oversight. ESG investors may consider whether executive pay is reasonable, if the company’s board of directors is diverse, the potential for conflicts of interest for the board and the board’s responsiveness to shareholders.
ESG investors consider a company’s record in these three areas, along with financial performance, when making investment decisions. Independent ratings provided by third-party companies and research groups help investors assess a company’s ESG policies.
ESG-focused investors build their portfolios by buying shares of companies because of their impressive ESG policies and high ESG ratings, rather than excluding whole industries, allowing for a more diversified portfolio. Alternatively, investors can purchase shares of mutual funds that exclude stocks not compliant with the ESG philosophy or ETFs that track indices.
Originally, people believed that ESG investing meant sacrificing returns. But ESG-focused ETFs and funds have performed well. Investors now believe that ESG investing will improve returns because of the additional factors considered when selecting a company. Further, the research shows that ESG investing helps mitigate risk in portfolios.
Recognizing the growing emphasis on ESG by investors, the Securities and Exchange Commission (SEC) has made ESG investing one of its priorities and has launched a new webpage to provide information on ESG-related investing and agency actions. The SEC also launched a climate and ESG task force to create initiatives to identify ESG-related misconduct and identify material gaps or misstatements in issuers’ disclosure of climate risks under existing rules. The SEC will also be reviewing proxy voting policies for investor risks on climate change and ESG matters.
Other Strategies for Socially Conscious Investing
One size does not fit all when it comes to investing. Several other strategies allow investors to align their investments with their values.
Socially responsible investing (SRI) happens when an investor chooses a company that is precisely in line with their social and environmental values. In contrast to ESG, which factors in corporate performance, SRI focuses solely on the investor’s values.
Impact investing allows investors to invest in market segments dedicated to solving problems around the world. The Global Impact Investing Network has four established guidelines for impact investing: intentionality in the investment to make positive social or environmental change, investment with return expectations, range of return expectations and asset classes and impact measurement that allows for transparency to assess how investor dollars help achieve meaningful change. Impact investing may generate lower returns due to concessions investors make to support earlier-stage ventures in less developed markets.
Conscious capitalism is the belief that companies should act with the utmost ethics while they pursue profits. The four attributes of conscious capitalism are higher purpose and larger impact on the world beyond money and market share, stakeholder orientation in which all stakeholders’ needs are balanced equally, conscious leadership that focuses on inclusivity and conscious culture that promotes the values and purpose of the company. The leader of a company typically embodies the principles of conscious capitalism, so they in turn run a company with a high ESG score. When an investor engages an ESG strategy, they will likely choose companies that embody conscious capitalism principles.
Whatever your investment philosophy, remember, even the most carefully selected investments come with risk. While research and careful planning can mitigate the inherent risks associated with investing, it is impossible to know if the executives and board members responsible for managing the companies or funds you invest in will always do the right thing. Be diligent and vigilant.