The stock market: the lifeblood of the capitalist machine that’s slowly but surely eroding human rights and destroying the environment. Right?
Well, not necessarily.
ESG Investing, a.k.a. “socially responsible investing” a.k.a. “sustainable investing” is a way of making investment decisions that with environmental, social, and governance impacts in mind.
That’s right: the idea behind ESG investing is that you can grow your wealth while feeling good knowing your money isn’t supporting deforestation, or inhumane working conditions, or any of the myriad other ethically sickening symptoms of the global economy.
So, if all of this sounds exciting, if you’re looking for a home for your money that will make you feel good more often than when your monthly statement arrives, keep reading. We’ve got a complete breakdown of all things related to ESG investing.
QUICK NOTE: Investing is inherently risky, regardless of how warm and fuzzy your choices make you feel. Despite how well-researched and authoritative this blog is, you should absolutely speak with a financial advisor before making any final decisions about where and how to invest.
We mentioned that ESG investing is sort of synonymous with socially responsible investing, but what does that really mean?
Basically, you can break ESG factors down into three main components: Environmental, Social, and Governance. ESG investing focuses on these factors when making investment decisions.
The way investors are able to choose companies that adhere to the environmental, social, and governance ideals they share is by looking at ESG scores. These scores are generated by third-party firms who assess companies based on ESG factors and score them accordingly.
Here’s the gist of what’s considered when determining a company’s ESG score:
There are several environmental factors that could be taken into account when determining a company’s ESG score.
Considering a company’s corporate social responsibility involves a few different factors as well.
Governance here means the leadership structure of the company itself, rather than how the company interacts with local, state, or federal governments. When considering a company’s governance, you’re looking at criteria like makeup of the board of directors (i.e. how diverse it is), executive compensation vs. employee pay, transparency of business practices, and overall ethics of how the company is run.
What ESG investors should consider:
Obviously, earning gold stars in all of these categories is a hard ask. Sure, Google has been emission-free since 2017, but their consumer data gathering practices have been called into question for being unethical. Subaru’s plants are all waste-free, but they produce cars which run on fossil fuels, and haven’t exactly been at the forefront of the electric vehicle boom.
At the end of the day, you can prioritize whatever ethics matter most to you when developing ESG investing strategies. When you speak with your financial advisor (remember you should do that), they’ll be able to help guide you as well.
Before we answer this question, we want to again mention that, before you do any sort of investing, you should absolutely 100% speak with a financial advisor.
In case there’s any confusion, reading this blog does not count as speaking with a financial advisor.
Okay, disclaimer disclaimed.
The short answer is that ESG investing is…fine as investment strategies go.
Of course, it’s a bit more complicated than that. Anytime the sawdust of government regulation get mixed up in the dough that is the free market, some folks are going to start flinging loaves in anger.
Which means that the wellbeing of ESG investors’ portfolios is going to be subject to all of the same market fluctuations as traditional portfolios, and could potentially fall prey to political fallout.
(For example, Florida governor Ron DeSantis recently signed into law a bill prohibiting any state officials from investing public money in any funds promoting ESG factors and from selling ESG bonds.)
Current ESG investment performance
One of the main ways people make ESG investments is by investing in mutual funds that exclusively buy into companies that meet certain ESG criteria. Like all mutual funds, ESG funds are managed by a fund manager, who makes all the decisions about where to invest the fund’s money.
In 2022, ESG funds slightly underperformed traditional funds in terms of overall growth, though both saw a decline in value in 2022. At the end of the year, traditional funds had lost 15.7% of their value, while ESG funds had lost 19%.
It’s worth noting, however, that in 2019, 2020, and 2021 ESG funds outperformed traditional funds by as much as 5% (in 2019).
The future of ESG investing
Given that renewable energy technologies are developing rapidly and that, according to the International Energy Agency (IEA), renewable energy sources are expected to overtake coal as the number one provider of energy in the world by 2025, ESG investing could be a safe long-term bet, especially if you focus on ESG factors that are environmental in nature.
Well, it hasn’t yet.
However, if you believe in the truth of the free market, the more people who invest money in companies involved in meeting ESG criteria, the better those companies will do, hedging out those who refuse to adapt to the environmental, social, and governance concerns of investors, and the result will be that the world is changed for the better.
Unfortunately, there’s a lot to be skeptical about when it comes to the overall concept of ESG investing, right down to how that label gets applied and which companies are included in ESG portfolios.
Concerns about ESG funds
Knowing whether or not an ESG fund’s investment decisions actually benefit the planet and society overall is terribly fraught and complex. Want a mind-boggling example? In 2022, the S&P 500 ESG index dropped Tesla (a company that makes electric vehicles) from it’s list, while Exxonmobil (a company that drills for and sells oil) remains.
So, anyone with money in that index patting themselves on the back for demonstrating climate conscious leadership within their peer group did so while being invested in one of the largest oil companies on the planet. Oops.
Another major issue with ESG investing is the concern that ESG fund managers don’t scrutinize the ESG scores of the businesses they choose to invest in.
Part of that issue is, as of 2023, there are over 140 individual, third-party organizations that calculate ESG scores for companies and they all have their own ESG criteria and process by which they score companies.
On top of all that, these companies can only assess ESG criteria based on data provided by the companies themselves, so the accuracy of a company’s data reporting is hugely important for being able to generate an ESG score that is actually reflective of their business practices.
What’s more, while the SEC does regulate data reporting of environmental, social, and governance factors, the enforcement of these regulations tends to be rather toothless.
So, at this point, it might be difficult for someone interested in ESG investing to be certain whether the companies their chosen fund invests in are actually adhering to sustainable investing standards of if they’ve figured out how to gamify their data to get included in ESG investment packages.
This has led to the perception amongst some financial professionals that the whole idea of responsible investing through ESG considerations is a bit of a hoax.
ESG investing, a.k.a. sustainable investing, is a term that indicates the investment decisions made by a particular fund are done so with consideration of environmental, social, and governance issues in mind.
Mutual funds that claim the ESG label only invest in companies that have earned a certain ESG score, which is determined by one of many third-party groups.
Here’s a quick breakdown of the factors that make up a company’s ESG score:
ESG investing performance
Funds with the ESG label performed slightly worse than traditional funds in 2022, however, because many of them incorporate sustainable energy companies which are slated to overtake coal as the main supplier of energy to the world by 2025, it’s quite possible that such funds will begin to overperform. The future, however, remains difficult to predict.
Issues with ESG investing
Many institutional investors have begun to think of sustainable investing portfolios as a bit of a scam. Because of the lack of regulation around data reporting that determines how shadowy third-party organizations dole out ESG designation, knowing your money is “doing good” for the world (which is sort of the whole promise of ESG investing) is kind of impossible.
So, ESG covers environmental impact, social impact, and ethical business practices.
There are over 140 independent organizations that score companies on ESG practices, however, so there isn’t a whole lot of consistency in terms of how ESG integration is assessed company-to-company.
In fact, despite the near-industry-wide skepticism of the whole ESG strategy in investment, most major investment firms offer “responsible investment” products with the ESG label.
In terms of how the funds with the ESG designation perform compared to traditional ones, they are currently underperforming slightly. However, that may change as sustainable energy becomes a larger factor in our society.
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