ESG is like the “organic label” of the finance world — does anyone really know what it means?
While it can be defined in several ways, the acronym “ESG” stands for environmental, social and corporate governance. An ESG investing strategy aims to invest in companies that embody these characteristics. That’s easier said than done.
ESG investing currently lacks a universal structure to help quantify and compare investments. Momentum is gaining to formalize policies to make ESG investing more transparent, with the Securities and Exchange Commission (SEC) making its move on the topic this week.
One thing is for sure: The trend to combine personal values with investment decisions isn’t going away. It’s only expected to grow more popular.
ESG: A Booming Investing Trend
ESG investing has been growing in popularity for years. Since the onset of the pandemic, companies have felt an increasing expectation and responsibility to address many of the new challenges individuals and communities are facing. Money flowing to ESG and socially responsible funds has surged in recent years. In 2021 alone, a massive $70 billion inflow of cash flooded U.S. “sustainable” funds — a 35% increase from 2020’s previous all-time high. Globally, the ESG market is expected to reach $50 trillion by 2025.
Young investors will be the driving force of this movement. A 2021 CNBC survey found that one-third of millennials often or exclusively invest in securities with ESG factors considered, compared to just 2% of baby boomers. But while millennials are investing in the sustainable values they believe in, they’re still of the mindset that they are giving up performance in return for these investments.
One of the greatest misconceptions about ESG investing is the idea that financial returns must be sacrificed to invest in the stewards of good. Investors sometimes rationalize this by thinking of the social or environmental return as part of their financial return. In reality, the data shows this fancy math is not necessary. ESG performance has historically tracked the market, and in recent years, ESG has outperformed the broader market. ESG investing is not a tradeoff — it can be a powerful way to reach your personal and financial goals.
Making ESG investments can be difficult given the lack of uniformity in tracking. Certain rating agencies offer scoring systems, but each agency may use varying indicators to measure the same ESG trait, for example. This is where regulatory oversight can help. This week, the SEC proposed new climate change disclosure requirements, asking companies to share current climate related risks, as well as future targets and transition plans. This type of transparency would be a step in helping make better investment decisions.
How to Invest in ESG Right Now
It will likely be some time before any standardization is put into place. Yet the trend toward sustainable investing isn’t slowing down.
So how do you go about investing in companies that prioritize ESG versus those that don’t? Here are a few options that can make an impact:
- ETFs and mutual funds. Perhaps the simplest approach to gaining exposure to the growing ESG trend is to buy a fund that screens for such. ETFs and mutual funds give you the benefit of diversification and ease of implementation. But be sure to check the fees — there are many low-cost options out there these days.
- Research and buy individual stocks. Right now, it can be a challenge to decipher if a company is “doing good” or not. There are resources (such as Sustainalytics, owned by Morningstar) that rate the degree to which a company is at risk given ESG factors. Other firms, such as MSCI and S&P Global, offer ESG ratings, too. While ranking systems continue to evolve, these tools provide a good starting point for researching individual stocks. But don’t rely solely on ESG scores — do your homework on the viability, growth prospects and valuation of the company as well.
- Invest in “quality.” One interesting trend of late is the connection between high scoring ESG stocks and the factor of “quality.” Profitability is a key characteristic of quality, and ESG stocks tend to be more profitable than those with low ESG rankings. Many companies that employ ESG strategies tend to be longer term thinkers — a positive characteristic that may lead to higher quality businesses, better positioned to face the potential challenges of the future. ETFs with a quality focus can be an indirect way to invest in ESG.
- Vote with your feet (and wallet). You don’t have to be a big investor to promote the ESG movement. Simply shopping at companies that emphasize values (and not just profits) is an easy way to support ESG. You can also donate to charities and causes near to your heart. Finally, volunteering your time and energy to a worthy mission can provide dividends beyond the financial type.
The Bottom Line
The ESG movement continues to evolve, and investors are eagerly putting their money where their mouths are when it comes to investing in the movement. Cleaning up the environment, promoting social values and equal opportunities for all, and having a sound governance structure are more important corporate virtues than ever before. You, as an investor and consumer, have many ways to put your money to work in this growing trend.
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Lindsey Bell, Ally’s chief markets & money strategist, is an award-winning investment professional with a passion for personal finance and more than 17 years of Wall Street experience. Bell’s unique ability to connect the dots between data and real life and craft bite-sized money ideas that people can use and apply stems from her deep background as an analyst, researcher and portfolio manager at organizations including J.P. Morgan and Deutsche Bank. She is known for demonstrating why and how an understanding of all things money improves a person’s finances and overall well-being. An ongoing CNBC contributor, Bell empowers consumers and investors across all walks of life and frequently shares her insights with the Wall Street Journal, Barron’s, Kiplinger’s, Forbes and Business Insider. She also serves on the board of Better Investing, a non-profit focused on investment education.