ESG Investing: What You Need to Know
Good for your conscience and wallet!
ESG investing helps you build a more ethical portfolio. The letters ESG stand for environmental, social and governance, and ESG investing is a form of socially responsible investment that aligns with your values.
According to financial site NerdWallet, socially responsible investing has taken the world by storm, “and providers and investors alike are scrambling to jump aboard the sustainable bandwagon.” Companies are often vocal, and even outspoken, about where their alliances stand when it comes to certain causes.
For example, a factory may only use eco-friendly, solar-powered machinery, which may appeal to a certain investor who supports green causes. If the earth’s carbon footprint is important to you, this is a company you may personally want to support. Against animal testing? Perhaps a cosmetics brand that does not test any ingredients on animals the company is for you.
If you decide that socially responsible investments are something you’re interested in, you can always research and verify that the company’s values align with yours. Even though there are many ways to make extra money, for some investors, a lack of connection on this level can be a dealbreaker.
How to get started with socially responsible investing
If you’re new to ESG investments, don’t panic. Yes, launching a portfolio and then researching companies that are as like-minded as you are can be daunting, but only if you let it!
Governance investing, and researching the overlap between a company’s ESG criteria and your own values can actually be fun. NerdWallet outlines some helpful ways to get started. And, of course, consulting with a finance expert, stockbroker, and/or accountant is a fantastic idea too.
Explore financial markets and ESG companies that resonate with you
According to MotleyFool, the financial performance of ESG stocks has recently drawn investor attention, and they want more. “During the market turbulence related to the COVID-19 pandemic, many companies with strong ESG track records showed lower volatility than their non-ESG counterparts,” explains the finance site.
Additionally, to many esg investors, that performance validated ESG investing and its premise — that good corporate behavior results in better business. MotleyFool advises you to “make your portfolio reflect your best vision for our future. Always be thinking ahead. Be optimistic. Think about the world that you want to create, because sure enough your dollars and mine, our capital, is helping shape the world.”
Michael Sikorsky, CEO of Copia Wealth Studios, says: “Most important, don’t look at the dollars generated, look at your return in terms of percentage.” For example, imagine you invest $100 dollars, and it rises to $120 dollars. “That is only $20 dollars for lunch. Does not seem worth it, does it? However, that is a 20% return, which is amazing.”
If you are unsure or new to investing, advises Sikorsky, start with a diversification strategy. “For example: Pick a broad-based ETF vs. say 2 to 3 company names.”
Sikorsky also says to track your investing in a google sheet, and journal why you are buying, and journal why would you sell before you even buy? “Document your time horizon for this investment, etc. This stops narrative shifting and grows your skills as an investor.”
He adds: “Decide what you are benchmarking against. Always have a benchmark to compare yourself to. Everyone needs a yardstick in order to grow taller.”
Read up on companies–thoroughly
Once you’re ready to create an ESG-style investment portfolio, it’s time to deep dive into the company. Put your research and investigative cap on. Look up a company’s sustainability initiatives and check to see if a company’s values are “in alignment with your moral compass,” stresses NerdWallet.
For example, if a large company donates some amount of money every month to breast cancer research, and that appeals to you as a breast cancer survivor, this may be a brand you want to throw your hard-earned money behind.
Open a brokerage account
You cannot start ESG investing until you set up a brokerage account, such as TD Ameritrade, Robinhood, E-Trade Financial, and so forth.
A brokerage account helps you buy and sell securities, explains NerdWallet, like stocks, bonds and mutual funds. Currency is transferred in and out of brokerage accounts—similar to a bank account–but unlike banks, brokerage accounts give you stock market access. (And FYI: brokerage accounts are also referred to as taxable accounts, because investment income within a brokerage account is taxed as a capital gain.)
Again, this can be overwhelming so keep this in mind: some brokerages offer resources to help you sift through various ESG (or sustainable/socially responsible/ethical) investments. Building an investment portfolio takes time, stresses NerdWallet, especially when you are trying to find investments that align with a particular framework, such as ESG. Do as much research as you can before financially supporting a company that catches your eyes.
Consider working with a Robo-advisor
Help is on the way if you need it in the form of Robo-advisors; digital advisors who build and manage investment portfolios. To be upfront, they’re often times less expensive than in-person advisors. (Not that an in-person advisor isn’t quite resourceful.)
Today, many robo-advisors are allowing investors to opt into a sustainable portfolio for no additional charge. Just make sure the Robo-advisor knows which causes and missions align with your values when helping you lock down your socially responsible portfolio.
Sustainable investing: Thinking about your values
What if you have too many values, too many causes that are personally important to you? You can’t invest in nineteen companies at once… (well, you can if you have the finances, but that’s still a lot.)
Says NerdWallet: “ESG has some pretty clear boundaries, especially in comparison to “ethical investing” or “socially responsible investing,” but that doesn’t mean it fits perfectly with your beliefs.”
Never forget that values differ from individual to individual, so really think about scenarios and viewpoints most important to you, and see if any fall outside of what “ESG” entails.
For example, Muslim investors may want to ensure that their investments comply with Islamic law. Or, let’s say a corporation vocally supports Planned Parenthood but you’re staunchly pro-life. This may not be the company for you to financially back.
Also, if you’re willing to make an exception, that’s OK as well. Do what feels right, and what you can financially juggle.
As they say, put your money where your mouth is, so if you’re really passionate about something such as the planet’s carbon footprint, look into sustainable investing that aligns with your passion for the environment.
How does ESG investing work?
Congrats! You’ve set up your brokerage account and you know what industries (or solo companies) you want to support with your investment strategy and investment dollars. Here are the next steps.
First, read reviews from independent research firms (such as Morningstar, as recommended by NerdWallet) which can show you how a company or fund “scores” in terms of ESG investing factors. This will help you decide whether you’d like to invest in them.
If a certain company catches your eyes, and you think it has growth potential, consider buying its stock. Check and see if that company has an impact report, which features any sustainable or cultural initiatives the company has implemented over the years. Curious how a company scores in terms of its work environment? Popular business sites such as Glassdoor can give you “scoop” on the company’s inner working and internal vibe and culture.
Adding mutual funds
The number of ESG funds has surged in recent years, says Morningstar Data in a 2020 study. You’re not the only one interested! This study explained there were 303 open-end and exchange-traded funds in 2019, which was up from 270 in 2018. “Some of these funds focus on a particular issue, such as green energy, making it easy to personalize your portfolio’s area of impact,” explains NerdWallet.
So, ask your broker if they offer a mutual fund screening tool. With it, you can compare different funds to further explore their ESG ratings. Want the nitty gritty? For additional details of a particular fund, says NerdWallet, such as what companies the fund invests in, you’ll want to look through its prospectus.
“This document should be available on your online broker’s website, and will include other helpful information like the fund’s expense ratio.” (Defined as annual fees taken as a percentage of an investment.) A mutual fund calendar can help you figure out how much you’d pay to own a specific fund.
How ESG’s are scored
They’re calculated by various companies that use a variety of methodologies. Most providers outline specific ESG indicators. Additionally, says NerdWallet, the way providers acquire their data differs as well. “For example, MSCI ESG Research, one of the largest independent providers of ESG ratings, uses data that is collected from both company disclosures and government, academic and NGO databases.”
Plus, the finance site points out, The Dow Jones Sustainability Index “uses an industry-specific questionnaire to gather self-reported data from participating companies.” CFA Institute plays a crucial role in ESP analysis; they’re a leader in environmental, social, and governance (ESG) factors in financial analysis.
Outlining ESG metrics
Today, investors incorporate ESG data into the investment process to gain a fuller understanding of the companies in which they invest. As outlined on the CFA Institute website, investors are” increasingly applying these non-financial factors as part of their analysis process to identify material risks and growth opportunities.”
ESG metrics are not usually part of mandatory financial reporting, states CFA Institute, though companies are more and more often disclosing them in their annual report or in a standalone sustainability report. They know potential investors want to see these stats.
“Numerous institutions, such as the Sustainability Accounting Standards Board (SASB), the Global Reporting Initiative (GRI), and the Task Force on Climate-related Financial Disclosures (TCFD) are working to form standards and define materiality to facilitate incorporation of these factors into the investment process,” says CFA Institute.
As the demand for ESG investing increases, on the flip side there are specific key trends emerging. The coronavirus pandemic has affected investing as a whole, and, says CFA Institute, “intensified discussions about the interconnectedness of sustainability and the financial system.” In response, CFA Institute is producing valuable research, collaborating with experts and practitioners for discussion, “and setting standards to enable the mainstreaming of ESG investing.”
Conviction and diversification
There really is a conviction and diversification framework to consider when investing, says Sikorsky. “When it comes to diversification, you have a belief in the ‘sector’ or ‘approach’ but you don’t have belief in any few names of companies. This has the trend for lower returns and hence a lower chance of loss of capital. “
Adds Sikorsky: “You have belief in a few names of companies, so you’re willing to be concentrated amongst them. This has the trend for higher returns and hence, the higher chance of loss of capital.”
It’s very possible to invest and make money while also being ethical. “Investing can go both up and down,” says Sikorsky. “But look at this: S&P 500 annual historical returns since 1926 is 8 percent. Let’s take a concrete example and look at an ETF under the symbol GRID. GRID is First Trust Nasdaq Clean Edge Smart GRID Infrastructure Index.”
You can also look up its ESG score and factors using this. “Then you can break down many factors from each of the classes of ESG.”
Analyzing the ESG score
Remember: anyone can buy an ESG fund with low amounts of money and feel good they are investing sustainably.
According to Craig Kirsner from Stuart Estate Planning Wealth Advisors, a company’s ESG score is, simply put, a numerical measure of how it is perceived to be performing on a wide range of environmental, social and governance (ESG) topics. One way to learn the ESG number is by going to MSCI’s website.
Or you can subscribe to Morningstar Direct ESG service.
Fidelity, says Kirsner, also has a nice page on ESG investing here.
The major benefits of ESG investing
“You get to be part of the change you want to see in the world,” says Sikorsky, referring to his fave quote: “Never underestimate the impact of a small act.” –Tory Burch.
And, adds Sikorsky, according to a Morgan Stanley Institute for Sustainable Investing report: In a study of more than 11,000 mutual funds, they found there is no financial trade-off in the returns of sustainable funds compared to traditional funds, and they demonstrate lower downside risk.
“Strong statistical evidence that sustainable funds are more stable.” Stresses Sikorsky: “In summary, impact investing is good for your wallet as well.”
Today, adds Kirsner, more people want to invest responsibly, so some of the world’s largest companies are acknowledging the importance of issues such as climate change, human rights and social inequality. Take a chance and invest and watch your portfolio grow— while simultaneously investing in your passion and conscience.
Need more inspiration? Take a look at these money quotes, they may just change your perspective on making money!