Investing money isn’t always the most straightforward prospect. There is a fair amount of ‘jargon’ involved. Phrases such as factor reversal, tracking error, correlation, volatility, and other phrases only add barriers to understanding how investing works. And with Wall Street’s reputation of enabling inequality, it’s understandable why some BAUCEs feel wary of investing altogether.
But, there is hope for the socially conscious investor. Over the past decade, more and more firms have offered strategies and investment vehicles that adhere to Environmental, Social, and Governance (also known as “ESG”) parameters. ESG intends to amplify investments whose standards of conducting business benefit the environment and society. Does this sound intriguing? Read more below to see why ESG investments may make sense for your portfolio.
Background on ESG Investing
As the name suggests, there are three core components of the ESG investment framework. First, there is a consideration for the environment. When analyzing a strategy through this lens, an investor considers whether the company uses fossil fuels instead of clean energy. Does the business in question negatively impact endangered animal species or otherwise hurt biological diversity? There is also the social part of ESG to consider. Are there material pay gaps between different genders and/or ethnicities at the company in question? How does the business approach diversity and inclusion? Are there any instances of human rights abuses or exploitation? These are all essential questions that drive the social aspect of ESG. Finally, the governance pillar of ESG entails the composition and behaviour of leadership. Has corruption created issues for the company? Does the business regularly conduct audits? Governance centres on policies and standards that reduce the likelihood of adverse outcomes for stakeholders such as consumers and communities.
ESG has Geopolitical Roots
According to MSCI, a multi-asset financial firm, ESG investing has been an important topic to investors since the 1960s. During this time, investors wanted to align their dollars with their principles. Therefore, they refused to invest in companies that benefitted from Apartheid in South Africa. This mindset ties into a broader history of boycotting companies whose actions bear harmful implications. When apartheid ended in the 1990s, it became clear to many investors that they should apply their morals to their investment decisions. ESG gained further traction in the 1990s. By 2000, the United Nations had established the UN Global Compact. This agreement outlines how businesses should conduct operations in an environmentally and socially conscious manner. The Global Compact incorporates instructions about how businesses should uphold human rights, support sustainability, and oppose corruption in all forms. Six years later, the United Nations unveiled the Principles for Responsible Investment, which outline how companies can implement, track, and develop ESG-friendly practices in their course of business.
You can Choose Your ESG Adventure
There is not a one-size-fits-all answer to ESG investing. On one hand, some investors may choose to actively avoid investments that conflict with their morals. Tobacco, large pharmaceutical companies, fossil fuels, and weapons companies often fall into this category. Therefore, BAUCEs who oppose these causes can invest in specific companies or broader stock indices that don’t engage in those specific areas. Firms such as FTSE offer funds that exclude fossil fuels, nuclear power, gambling, alcohol, firearms, and other sources of controversy. On the other hand, people can embrace investments that align with their values. So this approach focuses on including the “good” rather than excluding the “bad.” For example, some investments focus on clean energy, women-owned businesses, or healthcare accessibility. There are several paths in ESG, and options will expand as more and more players enter the field. Janet Y, a multi-asset class investment specialist notes, “Investors have always emphasized governance as an investment parameter. But in the last decade, environmental concerns and social concerns have come to the fore. This is particularly true for individual investors and families who want their assets to be invested in a way that aligns with their sensibilities.”
ESG Investments can Potentially Generate Strong Returns
At this point, ESG may sound too good to be true. Can you make a positive impact and keep those returns looking right? Believe it or not, ESG investments can create positive outcomes for your heart and your bank account. Of course, there is always the possibility of negative performance regardless of an investment’s ESG stance. A September 2021 study by Forbes found that a peer group of ESG-oriented hedge funds outperformed their non-ESG peers on a 3-year, 5-year, and 10-year horizon. However, ESG funds have struggled in 2022 amidst challenged performance in technology stocks (which tend to be in ESG funds). As a long-term investor, it is important to pay attention to the big picture rather than fixate on short-term market uncertainty.
ESG investing presents a fascinating way to potentially align your values with your portfolio’s valuations. Selecting an investment that promotes social equity, environmentalism, or community can be a profitable and powerful method of merging morals and money.
