Good news: It’s now easier than ever to reach your financial goals without feeling like you need to ignore your belief system. You may have heard the term “ESG investing,” which stands for environmental, social and governance—or its predecessor, SRI (socially responsible investing). The idea is to help investors understand whether publicly traded companies adhere to specific guidelines around environmental, social and governance issues.
Twenty years ago, being a socially responsible investor meant you might have to give up performance to keep your conscience clear. The story changed dramatically when, in January 1999, United Nations Secretary-General Kofi Annan introduced his “Global Compact.” The compact asked business leaders to share “values and principles, which will give a human face to the global market.” As more companies got on board with the Global Compact, they also started to report their results in their shareholder communications—which effectively meant investors could better determine whether a company adhered to solid climate change policies. A sub-industry of ESG research was born, which allowed investors to rely on concrete numbers and metrics that demonstrated real progress.
Risks and Rewards
Armed with information, investors poured money into sustainable investing— and the past few years have seen the biggest jump. Sustainable investing assets now account for $8.4 trillion of the total U.S. assets under professional management, according to the US SIF Foundation’s 2022 biennial Report on US Sustainable and Impact Investing Trends released in December. This represents 13 percent of the total US assets under professional management.
The investment is paying off for many. According to a report by McKinsey & Co.: “A strong ESG proposition correlates with higher equity returns” and “also corresponds with a reduction in downside risk.” And The Kenan Institute of Private Enterprise found recently that “in the short run, companies with high ESG ratings can experience higher stock returns as the number of investors who care about ESG factors increases. This derives from ESG investors’ willingness to pay a premium for these companies, thus driving up their stock prices.”
Of course, not all ESG funds thrive, and doubters still abound. Venture capitalist Chamath Palihapitiya, who made his fortune as an early employee at Facebook, called ESG investing a “complete fraud” and “a lot of sizzle, no steak,” when he appeared on CNBC in February 2020. Economist Burton Malkiel, who wrote the legendary stock market book, A Random Walk Down Wall Street, takes issue with how companies are rated and worries that those who are analyzing ESG issues “can’t even agree on how to evaluate these companies.” And the US SIF report also found that “multiple money managers reported a modest to steep decline in ESG assets under management, which the US SIF Foundation believes is a reaction to the SEC’s release of the fund disclosure proposal.”
What’s more, while a company can score well on the environment, what if it does not do so well on governance? As a whole, that firm may have a so-so grade, which means that as an investor, you may not end up with the kind of company you really want in your investment portfolio. Barclays advises investors “to do far more due diligence to ensure that their investments do indeed align with their objectives.” In other words, if you are really interested in pursuing ESG investing, you’ll need to cozy up to a mutual fund prospectus—or for publicly traded companies, their corporate disclosures outlining their benchmarks—to assess the screening process that each company employs, as well as whether the fund or firms aligns with your values.
How to Do It
A collective hunger for ESG investing has driven myriad investment companies to create more options. Morningstar has a list of low-fee ESG funds, which is a good guide. Vanguard’s FTSE Social Index (VFTNX) is among the top choices due to its expense ratio of just 0.12% annually. Other fund families to consider include Parnassus and Calvert, both of which have been committed to the ESG space for years.
If you want to experiment with ESG investing by purchasing stock in individual companies, it will take more time and research. The good news is that financial providers such as Charles Schwab, Fidelity Investments and SoFi now allow you to trade fractional shares (see page 6 for more info) of companies, making it more affordable to invest in stocks. The bad news is that purchasing individual companies can often lead to attempts to time the market, which can raise your risk profile and may distract you from your long-term goals.
Of course, because many Americans invest through their work-based retirement plans, you may face fewer choices. While some employer-based retirement plans include options for ESG investing, the vast majority have not yet added them. Your best bet is to join with a group of like-minded employees and ask your benefits department to add at least one ESG choice to the mix.
As ESG investing becomes intertwined with all investing, there is likely to be a much larger menu of choices available. OpenInvest, for example, a company founded in 2015, allows financial advisors to create and manage ESG-focused portfolios and helps them bring value-based investing into the mainstream. In my three-plus decades in financial services, I have found that as soon as there is an application of a concept that gains traction with advisors, it usually becomes more widely available to the larger investing public.
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Jill Schlesinger is a certified financial planner, business analyst for CBS News and host of the Jill on Money podcast