ESG investing has been gaining popularity over the last several years, and it looks like this trend is far from over as investors across the globe are looking for ways to align their investments with their values.
Whether you are an animal rights advocate, passionate about human rights, or just looking to support companies that treat their employees fairly, ESG investing is a way to foster your hopes for a better world by investing in companies that align with your values. As good as that sounds in theory, there are still common misconceptions and misunderstandings about what ESG is and what exactly it entails. Read on to learn more about the basics of ESG and how you can determine if it’s right for you.
The Basics of ESG Investing
ESG investing is a strategy that reviews the environmental, social, and governance practices of a specific company and assesses how those non-financial practices might impact the company’s performance in the stock market or external entities, such as the environment and our society. ESG aims to examine the total ethical impact of an investment, on both risk and return, and align investors’ portfolios with their moral values.
Because each investor has their own unique set of moral values, ESG can be difficult to define precisely. What is considered socially responsible to one may not be the same for another. According to the CFA Institute, the common consensus is that the different ESG factors are defined as follows:
Environmental factors focus on the conservation of the natural world, including how companies manage their impact on:
- Climate change
- Carbon emissions
- Air and water pollution
- Energy efficiency
- Waste management
- Water scarcity
Social factors consider how companies interact with people at both the employee and the consumer level. This includes:
- Customer satisfaction
- Data protection and privacy
- Gender and diversity
- Employee engagement
- Community relations
- Human rights
- Labor standards
Governance refers to the internal structure of a corporation and the policies and procedures for how it operates. Governance factors include:
- Board composition
- Audit committee structure
- Executive compensation
- Political contributions
- Whistleblower scandals
The ESG factors can be measured. For instance, carbon emissions, customer satisfaction, and board composition are all factors that can be readily determined for most large companies. Yet it is difficult to assign a monetary value to socially responsible practices in these areas. How much is a low score on carbon emissions really worth, and how will that impact a company’s long-term growth? Conversely, how risky of an investment is a company that has a high score in carbon emissions? These are the questions that ESG investing seeks to answer, but it is hardly a perfect science.
Another important consideration is the fact that ESG metrics are not a mandatory component of financial reporting, which means companies must self-report their policies and practices in specific ESG areas. In fact, estimates suggest that as much as 75-80% of the data used in ESG ratings is collected from self-reported information, leading to a general lack of transparency and accuracy. Additionally, each rating agency, like MSCI and Morningstar’s Sustainalytics, has its own proprietary criteria for ESG grading, may actually score only internal or external risks, and use different scales for grading (AAA-F vs. 1-10), which can add to the confusion and complexity around this investment strategy.
Socially Responsible Companies
Just because ESG reporting and ratings aren’t perfect doesn’t mean the concept of socially responsible investing should be dismissed. Several institutions, including the Sustainability Accounting Standards Board (SASB), the Global Reporting Initiative (GRI), and the Task Force on Climate-related Financial Disclosures (TCFD) are developing ways to formalize the ESG standards and incorporate them into the investment reporting process.
Not only that, but several companies are already demonstrating how socially responsible policies can help boost returns for investors.
- Kroger, which had a higher ESG rating than Walmart and Costco, performed better in the market after it announced that it would be giving its frontline workers bonuses, paid time off for COVID, and general financial assistance to its employees.
- In 2019, Microsoft stock rallied after the company earned the coveted MSCI AAA ESG rating for its commitment to data privacy, public disclosures, and positive global impact.
- Best Buy has also earned an MSCI AAA ESG rating for its handling of the pandemic and its board diversity, which is 60% female and has a female CEO.
There are many mutual funds and ETFs that provide ESG funds that can drill down to almost any social concern, like funds specifically addressing gender diversity on boards and executive management and ones that focus on workplace environments.
If you feel strongly about a cause or issue and believe investing in companies that do good can be good for your portfolio, then ESG investing may be right for you. At Wilkinson Wealth Management, we are dedicated to helping our clients incorporate ESG into their investment portfolios in a thorough and strategic way. To learn more about ESG funds and how we can help, call 434-202-2521 or email email@example.com to schedule an appointment.
Susan Wilkinson is founder, president, and financial advisor at Wilkinson Wealth Management, a financial services firm in Charlottesville, Virginia, providing customized financial planning and strategies with a personal approach. With over 25 years of experience, she has a passion to come alongside her clients to help them fulfill their dreams and grow their wealth so they can be financially independent. Susan is known for listening to her clients, digging deep into their values, concerns, needs, and goals so she can build a financial plan tailored to their unique life. She prioritizes building long-term relationships with her clients and being the person they call when life throws a curveball or questions arise.
Susan is a CERTIFIED FINANCIAL PLANNER™ professional and has an MBA from Webster University and a Bachelor of Liberal Arts in Economics and Sociology from the University of Mary Washington. When she’s not serving clients, you can find Susan outside, either gardening, biking, or hiking. She’s a homebody at heart who loves music, especially playing the piano and cello. One of her favorite things to do is spend time with family, including her husband, Terry, her children, and her twin granddaughters, whom she affectionately (and appropriately) calls the “twinados.” To learn more about Susan, connect with her on LinkedIn.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.
Socially Responsible Investing (SRI) / Environmental Social Governance (ESG) investing has certain risks based on the fact that the criteria excludes securities of certain issuers for non-financial reasons and, therefore, investors may forgo some market opportunities and the universe of investments available will be smaller.
Investing includes risks, including fluctuating prices and loss of principal. No strategy assures success or protects against loss.