This article was originally published on marcus.com.
Whether you’re a well-seasoned investor or you’re considering dipping your toes in for the first time, you may have heard of ESG investing. Particularly in the last few years, ESG investing has been increasing in popularity as investors realize profit and good business practices don’t have to be mutually exclusive. Learn more about what ESG investing is and if it’s right for you.
Diversity. Climate change. Fair pay. These socially-minded topics have been on a lot of our minds lately and are also coming up in investing. In 2020, ESG investing became increasingly popular. Sometimes referred to as “sustainable investing,” ESG investing is about pursuing profit and improving the world.
What is ESG Investing?
“ESG” stands for three broad categories investors can use to evaluate companies: Environmental, Social, and (corporate) Governance.
Environmental criteria look at how companies’ policies impact nature, both locally and on a global scale. Social criteria look at how companies manage their relationships, including those with clients, employees, suppliers, and the communities the company is a part of. The Governance aspect considers how companies run themselves, looking at factors like executive pay, shareholder rights, board composition, audits and so on.
Fund managers and financial institutions all have their own way of evaluating companies based on ESG factors. For example, one institution might have an ESG offering that avoids exposure in industries that are considered “sensitive sectors," like coal, tobacco or firearms.
ESG investing could make sense for you if you want to use your money to invest in and support companies that align with your values—and it doesn’t have to mean sacrificing returns. Fund managers offering ESG investing options will take returns into consideration when evaluating an investment. For example, if a financial advisor for an investor focused on ESG is comparing two funds as potential investments, and one fund has an ESG overlay in their investment process, all things being comparable, they might choose the ESG fund.
ESG Factors
Here’s what companies focus on for each category.
Common environmental criteria:
- Air emissions and air quality
- Energy efficiency
- Preservation of natural resources
- Waste management
- Land use
- Water scarcity
- Use of hazardous materials
- Pollution
- Treatment of animals
Common social criteria:
- Employee relations
- Customer satisfaction
- Data protection and privacy
- Providing equal employment opportunities
- What labor standards they follow
- Healthcare, education and housing services they provide
- Production quality and safety
- Impact on the local community
- Volunteer work they participate in
Common governance criteria
- Board diversity
- Voting rights
- Ethical business practices
- Auditing
- Accounting and tax transparency
- Political contributions
- Executive pay versus employee pay
Negative and positive screening for ESG investments
There are two main ways to screen potential ESG investments: negative screening and positive screening.
Essentially, negative screening means excluding companies that don’t align with an investor’s morals or values. For instance, when choosing stocks, an ESG investor may choose to exclude any company that tests on animals or produces alcohol or tobacco products.
While negative screening has been historically used by ESG investors, positive screening has become popular lately as well. Positive screening seeks out companies that align with their values, as opposed to excluding companies that don’t.
Before rushing to get started on investing in ESG funds, keep in mind that it’s not guaranteed that all of a company’s ESG practices align with your values. It might make sense to prioritize which criteria are most important to you and seek out companies/funds that match them.
Who is ESG investing a good fit for?
Naturally, the majority of folks interested in ESG investing are going to be socially and environmentally conscious investors.
If you believe your investment objectives and personal values can coexist, ESG investing could be a good fit for you.
While there’s been debate over the ability of ESG-based investments to really turn a comparable return to non-ESG investments, 2020 has largely made the point that it can. If we consider what a volatile year 2020 was for investing at large, ESG investments did pretty well! By late 2020, about 46% of ESG investments that were rated low-risk and about 30% of ESG investments that were rated high-risk, generated higher returns than their benchmark index.1
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1Source: https://www.morningstar.com/articles/1016714/did-esg-pay-off-for-fund-investors-last-year-yes-and-no
