ESG investing is on the rise as both individual and institutional investors seek to support companies that align with their values in three primary ways: environmental, social, and governance. Because of this surge in popularity, there are many ways to invest in company stocks based on their business practices as well as their growth potential. Learn more about ESG investing trends, including how to invest in both individual companies and funds.
So, what is ESG investing? ESG investing involves evaluating non-financial factors when choosing investments. However, you should still analyze the financial risks and growth opportunities just as you would with any other stock. When looking into ESG investment management, there’s no one specific approach since everyone’s social values vary. For example, investors with conservative or faith-based values may set investment parameters that promote pro-life organizations or exclude companies involved in stem-cell research. Those with progressive values may look to invest in companies with initiatives focused on women’s health and/or LGBTQ+ acceptance.
When one tries to evaluate individual companies based on ESG criteria, it’s important to understand where the ESG data metrics are coming from. According to the Global Initiative for Sustainability Rankings (GISR), there are well over 100 organizations that produce sustainability research and ratings on companies. These groups vary from non-government organizations that may focus on single issues to more global businesses covering the full spectrum of ESG. It’s important to note that whether you’re looking at third-party providers or specific benchmarks, there is no standardization for ESG reporting and ratings may vary from one provider to the other. It’s also very important you compare apples to apples by comparing one company to another using the same rating agency, rather than comparing two companies using different providers for each.
Here are some ESG factors usually associated with each category..
Whether you are interested in sustainable investing, impact investing, or building an ESG portfolio, there are many ways to begin your journey to responsible investing. You can always craft your own approach to value-based investing but beware that using ESG ratings usually comes with assumptions about a company’s practices. Here’s what that means when applied to both individual companies and investment funds.
Currently, the United States does not have a singular model for labelling a company as meeting specific ESG standards and for calculating an ESG score. There are, however, several leading industry institutions that are working on creating formal standards and definitions in order for a company to claim ESG status. The Sustainability Accounting Standards Board (SASB), the Global Reporting Initiative (GRI), and the Task Force on Climate-related Financial Disclosures (TCFD) are some of the organizations leading the effort.
Another way to determine the quality of an investment is to search for individual companies that interest you and perform a values-check against issues that are important to you. How large is the company’s carbon footprint? What kind of sourcing practices do they follow? How have they treated employees throughout the COVID-19 crisis? Look for news stories that reveal the good and the bad about your potential investments.
You can also work with your financial advisor to discuss the ESG qualifications most important to you. Then, they can work with you on several ESG investing strategies. You can rank and weigh companies based on your own criteria, purchasing a higher percentage of stocks or mutual funds that resonate with your values compared to those that don’t meet your standards. Or you can completely exclude a certain industry or company you strongly disagree with. Your financial advisor can help you prioritize your most important values, then create a valued-based portfolio that’s designed to grow with investments you feel good about.
Another increasing ESG investing trend is opting for mutual funds rather than cherry picking specific companies to add to your portfolio. This can be a convenient way to add some value-based investments to your portfolio, but there are a few things to consider before jumping on board.
First, check on the criteria for the fund to make sure they’re in line with your own values. Some may focus only on environmentally sustainable companies, while others may try to incorporate a gamut of ESG issues. Look carefully at labels and ranking criteria, otherwise you might not know exactly what you’re investing in or why.
Another thing to watch out for with ESG investment funds is their fees. According to The Wall Street Journal, exchange-traded funds (ETFs) that are focused on socially responsible investments are on average 43% more expensive than traditional ETFs. No matter who manages your money, expense ratios can eat away at your long-term portfolio growth. Not only do you need to evaluate ESG funds for the quality of stocks included, you also need to look at the total costs as well.
Your financial advisor should help you with this analysis. At D&Y, we help clients evaluate the costs of all your investment options to make sure you’re minimizing excessive fees while still achieving your goals.
As you consider what types of ESG investments to potentially include in your portfolio, it’s smart to stay on top of upcoming changes and areas of focus in this arena.
So far in the United States, ESG reporting is not mandatory in companies’ financial reports. However, many companies are voluntarily including in their annual reports or a separate sustainability report. In fact, in 2020, 90% of S&P 500 Index companies published sustainability reports. Usually, these reports include information on issues like labor, talent management, diversity, executive pay, safety, and data security. It’s a great direct source of information about a company’s priorities and identifies stocks that are committed to ESG issues in some way.
Certain fund managers are also seeing an increase in reporting requirements when it comes to any funds labeled as ESG. This regulation hasn’t arrived from American regulators yet, however, in the European Union, new disclosure regulations went into effect in March 2021, impacting funds in Europe as well as the U.S. (if those funds are marketed in Europe). Asset managers must provide the following information about how stocks are chosen for certain funds:
The U.S. Securities and Exchange Commissionopens PDF file (SEC) is in the process of gathering recommendations on ESG disclosures, so it’s very possible that additional domestic regulations will be a new trend in the near future.
As a result of the new Biden administration, recent SEC Acting Chair, Allison Herren Lee, issued a Statement on the Review of Climate-Related Disclosure. This is expected to lead to an update of current requirements on climate-related disclosure in public company filings.
2020 brought tremendous change to the world, along with a greater focus on several social issues highlighted by events throughout the year. The COVID-19 pandemic has shined a spotlight on worker safety in the U.S. For example, lawsuits arose against companies that lacked personal protective equipment (PPE) or proper social distancing standards in the workplace. There were some public companies that had their stock plummet and lost credibility with values-based investors because of these issues.
Protests across the country following the deaths of Ahmaud Arbery, George Floyd, and Breonna Taylor increased visibility on systemic racism in America. This places diversity, equity, and inclusion as a new priority in the ESG sphere. In fact, a report showed that there was a significant increase in race-related shareholder resolutions in 2020.
Unequal access to healthcare has also been a hot topic as a result of both major events of 2020. The increased impact of COVID-19 on specific racial and ethnic groups, paired with the high cost of healthcare in America has caused many investors to petition for better diversity initiatives in public companies.
ESG investing can be accomplished in a number of ways, from picking and choosing specific stocks to evaluating one of the many mutual funds and ETFs with an ESG focus. And as reporting requirements grow over time, it will be easier for investors to evaluate their options and find the best portfolio additions that line up with their own values.
However, it’s still important to enlist professional help to perform a holistic analysis of your investment portfolio and the value-based companies you choose. When it comes to overall investment advice, investment strategy, or you have specific questions about socially responsible investing, ESG risk, or ESG performance, you should meet with our team of investment professionals before making your next major investment decision. Talk to a D&Y advisor today to discuss your goals, whether they’re financial, issues-oriented, or a mixture of both.
Contact Dowling & Yahnke Wealth Advisors now.