At its simplest, ESG investing is a strategy where investors add environmental, social, or governance factors to their investing strategy.
Traditional investing encourages investors to focus solely on gains that are possible through their investments. ESG adds layers of responsibility and sustainability to consider before purchasing a stock or fund.
Contrary to popular belief, this is not a strategy that is focused on only idealism. ESG funds have real returns and the companies that manage them, as well as the companies that are categorized as ESG friendly, are beholden to shareholders to grow and make money.
In many instances, ESG funds outperform their traditional counterparts.
What makes a fund ESG?
Environment, society, and governance can mean a lot of things to a lot of people. At its most basic, the factors that are considered under each category are the following:
| Environmental | Social | Governance |
|---|---|---|
| Carbon emissions Air and water pollution Deforestation Green energy initiatives Waste management Water usage | Employee gender and diversity Data security Customer satisfaction Company sexual harassment policies Human rights at home and abroad Fair labor practices. | Diversity of board members Political contributions Executive pay Large-scale lawsuits Internal corruption Lobbying. |
Unfortunately, we’re yet to live in a world where any company is perfect (except may Patagonia?). For example, while Starbucks rates highly on gender pay equity, they’re not set to blow anyone’s mind when it comes to waste management anytime soon.
I tend to think that if we all sit around waiting for perfection, we’ll never get to good. I would much rather have shares in a company that has a couple of good ESG strategies in place, than a company that isn’t even thinking about its effect on the world.
How ESG investing is changing the game
In a 2019 Global Investor’s study, 60% of 25,000 investors who were interviewed believed that investment funds should consider sustainability criteria when making investment decisions.
The implications of this kind of mandate from investors are huge. When we invest, we each own a tiny piece of a company, and publicly traded companies’ main priorities are their shareholders.
As a result of the shareholder push towards sustainability, in 2022, 38% of the Global Fortune 500 has made a significant 2030 target for sustainability, up 8% from 2021. Spending on sustainability initiatives is expected to double in 2022.
Personally, I’m an optimist and an idealist, but I’m not so naive to think that business has recently taken a green turn out of concern for the environment. Business goes where the money is and ESG investing, along with consumer demand, is shifting the balance towards a greener future.
What is an ESG Score?
A standard criticism of ESG investing is greenwashing. This is when companies try to showcase themselves as environmentally friendly, but underneath the marketing, there’s nothing really there.
The antidote to greenwashing is cold hard facts – in the form of reporting on ESG metrics that are available to the public so we can make informed choices about our purchases and our investments.
Currently, the EU requires reporting from companies with more than 500 employees on the following:
- environmental matters
- social matters and treatment of employees
- respect for human rights
- anti-corruption and bribery
- diversity on company boards (in terms of age, gender, educational and professional bac
Unfortunately, the US is significantly behind. The US currently has no mandatory ESG reporting regulations at the federal level. However, the house passed a bill in 2021 that could spell change for the future. The bill would require all publicly traded companies to report on ESG related issues.
The best way to get this bill passed is to vote in the midterms this year. If democrats get a strong majority in the senate we could see real change when it comes to sustainability.
Examples of ESG Funds
Despite the lack of federally mandated reporting in the US, there are still plenty of options for getting into ESG investing now. In fact, there are more than 600 ESG funds available to investors today.
Many of the available funds are exclusionary funds, meaning they filter out bad actors. The following are exclusionary principles that Vanguard uses:
- Derive any revenue from involvement in controversial weapons, civilian firearms, nuclear power, or fossil fuels.
- Derive any revenue from the production of tobacco, cannabis, or conventional military weapons, or greater than 5% revenue from supplying or retailing these products.
- Derive greater than 5% revenue from the production of alcohol, gambling, or adult entertainment, or greater than 10% revenue from supplying or retailing these products.
- Do not meet the certain board and workforce diversity criteria.
- Have violations of labor rights, human rights, anti-corruption, or environmental standards as defined by the U.N. Global Compact principles.
Using these, Vanguard offers funds that are global, international or US broad market funds. A few of the ticker symbols are ESGV, VSGX and VFTAX.
Impact Shares offers a range of inclusionary options. In partnership with the YWCA, NAACP, Community Capital Management, and other impact-based organizations, they designed a variety of fund options. These funds support initiatives like women’s empowerment and diversity and inclusion, amongst others.
Remember, finding funds that support your values is half the battle. You still need to do your due diligence on financial performance before investing.
In closing…
ESG investing involves adding a new layer to your investment strategy. Instead of only looking at financial performance, you also look at environmental, social, and governance factors.
The strategy is young, relative to traditional investing. Thus, reporting requirements are not what they should be. The more of us who invest and vote for ESG transparency, the better things will get.
The more reporting that’s out there, the more opportunity there is for ESG investing to change the world for the better. And, for us all to make some cash money in the process.
