What is ESG Investing?

By Modern Wealth Management

July 24, 2020

What is ESG Investing?

Nowadays, when investors look at companies to invest in, they go much deeper than just looking at a company’s finances. As it turns out, business has a lot more to it than balance sheets and income statements. If there’s a social issue or a cause that’s important to you, chances are Wall Street has an investment that aligns with your values. Over the past decade, more and more investors are seeking ways to align their investment portfolios with their personal beliefs. With the increased demand for so-called “socially responsible” investments, investors have never had such a wide array of choices. If socially responsible investing is important to you, focusing your investments on ESG factors may be of interest. So what is ESG investing?

E for Environmental

The environmental factor describes how a company performs concerning environmental issues. These include things such as air and water pollution and the conservation of nature. A company committed to preserving the natural world and focuses on minimizing its environmental footprint will have a high score. Regardless of one’s thoughts on climate change, it’s evident companies are investing billions of dollars to minimize their environmental impact. During the 2020 Super Bowl, when commercials were running at an estimated cost of $5.6 million for a 30-second spot, Audi ran a minute-long ad touting their new electric car. Michelob Ultra also ran a commercial, raising awareness for a new campaign targeted towards helping farmers switch to organic agriculture, aimed at lowering pesticide use.

S for Social

Many companies are making headlines today for their stances on social issues. This is a wide-ranging factor, including civil rights, labor standards, engagement within a community, or the sale of specific products or services, such as gambling, alcohol, or tobacco. The social factor can be of particular importance to people with certain religious beliefs.

An investor who staunchly opposes firearms may not want the stock of businesses that manufacture or sell guns. Companies take note of hot button social issues and will sometimes implement new policies. In 2015, Wal-Mart announced that it would no longer sell semi-automatic rifles such as the AR-15, which many believe was in response to high profile mass shooting incidents. In 2014, CVS President and CEO Larry Merlo announced the company would no longer sell tobacco products in its stores.

There may be good reason to carefully inspect a company before investing with a keen eye on its social impact factor. According to S&P Global Ratings

“Some believe that prioritizing social factors in sustainable investing ensures that the companies included in an investor’s portfolio reflect his, her, or their values or pass a moral test. However, the prospect of profit creates another basis for examining the social impact and liability of a company and its practices. Simply put, the market will tend to reward those companies that minimize their exposure to these social issues—selling controversial products, relying upon materials from geopolitical hot spots and using an unpredictable labor force can hurt profits and increase volatility.” 

G for Governance

When assessing a company’s governance, factors like a company’s board of directors or its political contributions and lobbying efforts come to light. These companies may make a concerted effort to have a diverse group of directors on their board. In 2016, State Street launched its Gender Diversity Index ETF. According to their fact sheet, this fund “seeks to provide exposure to US companies that demonstrate greater gender diversity within senior leadership than other firms in their sector.” 

Executive compensation is a part of a company’s corporate governance, and something many companies can come under fire for. Recently the New York Times wrote about companies seeking bankruptcy protection while compensating their CEOs with millions of dollars in “golden parachute” deals. 

“J.C. Penney, which is closing 154 stores, paid its chief executive, Jill Soltau, $4.5 million. The chief executive of Whiting Petroleum, which sought bankruptcy protection in April, received $6.4 million, and Chesapeake Energy is paying bonuses ahead of an expected bankruptcy filing. Executives at Hertz also got payments before the rental-car giant sought bankruptcy protection.”

Does ESG investing lead to higher returns?

Of course, it’s always nice to feel good about the companies in which you invest. Obviously, many publicly traded companies are in a position to do real good in our world. While it sounds nice to align your investments in companies with your core set of beliefs or values, at the end of the day, investing is about earning some return on your money. And while life isn’t all about maximizing profits at all costs, investors generally don’t want to sacrifice significant investment returns to make that alignment between their portfolios and values. So, does ESG investing actually lead to better investment performance?

The results are mixed. One study by Morningstar in 2020 showed that while investors building a global portfolio with an emphasis on ESG have historically experienced slightly higher returns than a portfolio without a focus on ESG, investors in exclusively US-based ESG companies were at a slight disadvantage. 

Another study by the International Monetary Fund in 2019 showed, “For investors, the willingness to invest sustainably coexists with performance considerations. There is no conclusive evidence in the literature that sustainable funds consistently out- or underperform conventional funds… IMF staff analysis suggests that the performance of sustainable and conventional funds is comparable.” 

Is ESG investing right for you?

Whether or not ESG investing is appropriate for your situation is another issue. If there are issues important to you, it may warrant a more in-depth discussion with your financial advisor. Maybe even a deeper dive on your own if you manage your investments. If you’re interested in seeking out how a company scores with an ESG rating, there are several places where each has its specific methodologies for ratings. There are still risks associated with investing in even the most socially responsible companies. However, these companies can potentially benefit both society and your bottom line.

If you’re interested in talking about your opportunities and investment interests, reach out to us. Schedule a complimentary consultation or give us a call at 913-393-1000 and we’ll connect with you!

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The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.