With climate change, social change, and ethical business practices taking center stage in the news, it’s no wonder that socially responsible and ethical investing is growing in popularity among investors. The good news is that choosing such strategies does not come at the expense of performance.
Socially responsible investments are commonly known today as ESG funds. They focus on companies that follow ethical environmental, social and governance practices. Each ESG fund considers an investment through the lens of the company’s financial returns as well as its overall impact on the world.
Interest in ESG funds has grown rapidly as many Millennials, Gen Xers and Baby Boomers wish to have their investments aligned with their personal values. Many ESG investors believe this kind of investing helps companies address major environmental and social issues in meaningful ways. A recent Morgan Stanley study noted that 95% of Millennials are interested in ESG funds1 and approximately 25% of money under professional management globally is invested sustainably2.
What are ESG Criteria?
Although socially responsible investing has been around for decades, ESG funds have evolved around specific criteria that companies now must meet in three categories:
- Environmental – This metric favors companies having a positive impact on the environment or those using natural resources responsibly. Companies also may include those developing or selling eco-friendly technology such as wind turbines or electric vehicles.
- Social – Companies that actively embrace and promote inclusion, diversity and social justice are evaluated using this metric. The criteria may factor in company’s employment policies, board memberships and composition, business policies, and practices.
- Governance – This metric evaluates how well companies embrace accountability and transparency. Criteria considered include equitable pay policies, a diverse board composition, reasonable executive pay, ethical business practices, sound accounting practices, and financial metrics.
Currently, there is no single standard or governing body for rating ESG criteria, but several investment and rating companies have created their own metrics. There is movement to converge these metrics into a unified set of global ESG standards.
Changing the Perspective of Companies
ESG criteria have become widely accepted by many corporations, with 86% of S&P 500 companies completing ESG reports3. This trend is changing the nature of equity analysis. A 2020 study by the CFA Institute found that 85% of CFA members now take E, S and/or G factors into consideration for their investments4.
Similar to using technical and fundamental analyses, ESG metrics are being integrated by investors into their stock analyses. This differentiates ESG investing from previous socially responsible investment strategies which would typically exclude corporations that were deemed non-compliant from their investment pool.
Publicly-traded companies have taken note and are changing their business practices accordingly. Companies are beginning to see that making a commitment to ESG criteria can benefit both their bottom line and satisfy all their stakeholders.
How Well Do ESG Funds Perform?
ESG funds overall are showing strong results. In 2020, they outperformed traditional fund peers by a median total return of 4.3%, up from a similar outperformance of 2.8% in 20195. An earlier white paper by Morgan Stanley found that between 2004 and 2018, ESG total returns of sustainable mutual funds and ETFs were comparable to those of traditional funds6.
There are various reasons for these positive results, but perhaps the underlying factor is that ESG companies tend to be well-run organizations and thus have lower associated risks. By making a commitment to long-term policies that protect the earth, advance social justice, and create a better world for everyone, ESG companies may find they can create value for all stakeholders.
Should You Consider ESG Funds?
If you are interested in ESG investing, begin by thinking about your personal values and beliefs as well as what goals you have for your investment portfolio. We can help you better understand the ESG criteria and what may be included or excluded in the metrics. If you decide you want to pursue ESG investing for part of your portfolio, we’ll present you with options that suit your goals.
Please contact your advisor with any questions.
1“The Pros and Cons of ESG,” by Andrew J. Willms, The Milwaukee Company blog, Oct. 16, 2020. https://www.themilwaukeecompany.com/post/the-pros-and-cons-of-esg
2“Pros and Cons of ESG Funds,” by Kate Ashford, Forbes, April 19, 2019. https://www.forbes.com/advisor/investing/pros-and-cons-of-esg-funds/
3“Flash Report: 86% of S&P 500 Index® Companies Publish Sustainability / Responsibility Reports in 2018, “Governance & Accountability Institute report, May 16, 2019. https://www.ga-institute.com/press-releases/article/flash-report-86-of-sp-500-indexR-companies-publish-sustainability-responsibility-reports-in-20.htm
4“Future of Sustainability in Investment Management: From Ideas to Reality,” a special report by the CFA Institute, 2020. https://www.cfainstitute.org/-/media/documents/survey/future-of-sustainability.ashx
5Sustainable Funds Outperform Peers During Coronavirus,” Morgan Stanley Institute for Sustainable Investing blog, Feb. 24, 2021.
https://www.morganstanley.com/ideas/esg-funds-outperform-peers-coronavirus
6“ESG Investing: A Beginner’s Guide,” by Alana Benson, Nerd Wallet blog, April 19, 2012. https://www.nerdwallet.com/article/investing/esg-investing
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