ESG is a type of investing that prioritizes a company’s social and environmental impact. The acronym stands for “environmental, social and governance,” and it encompasses a wide range of factors that are used to evaluate the investability of a company.
Types of companies that fall under the ESG umbrella include those that don’t harm the environment, those that have ethical business dealings and those that treat their employees well. While formerly a fringe area of the investment world, ESG investing is now a booming industry. From dedicated mutual funds and ETFs to direct investing in hand-picked stocks, investors now have multiple ways to participate in ESG investing. Here’s a look at just a few.
Breaking Down ESG Investing
ESG investing isn’t just a trend or a fad. It’s a way for investors to put their money in companies that align with their moral and ethical principles. While ESG investors look to profit, like any others, they also use ESG investing so they can sleep at night, knowing that their money isn’t supporting any companies that conflict with their values. Some investors embrace each of the three legs of ESG investing, while others only select one or two. For example, one type of ESG investor might be fine with any company that doesn’t destroy the environment, while others only want companies that have ethical boards, treat their employees well and have no environmental violations. Thus, while the ESG investing universe may seem narrow at first glance, it is actually quite broad.
ESG investing used to be only for ethically driven investors who placed performance second to their investment principles. However, over the past few decades, the ESG investment universe has evolved to the point that ESG investing doesn’t necessarily mean a sacrifice in investment returns. In fact, S&P studied the performance of 26 ESG funds from March 5, 2020, to March 5, 2021, and found that 19 of them outperformed the S&P 500 index. Although not all ESG investments will outperform the S&P 500 over time, many of them have that potential. Take Tesla, for example. The electric vehicle maker led the S&P 500 in 2020 with a whopping 740% return.
Read on to see some ways to get involved in ESG investing.
1. Integrating ESG With Traditional Investing
Investors who don’t want ESG principles to dominate their investment criteria can integrate ESG concepts with traditional financial analysis. Rather than buying a company simply because it isn’t a polluter, for example, this type of investor will select a range of ethically compatible companies and then analyze them according to their financial characteristics. In other words, a company doesn’t just have to be “ESG-eligible,” it must also be well-run, with rising earnings and revenue, for example. By integrating basic financial analysis with ESG principles, investors can have the best of both worlds.
2. Negative Investing
Negative investing, as applied to ESG, refers to avoiding companies that clash with your personal principles. For example, if you’re opposed to the production of weapons, you’ll be sure to avoid investing in companies like Lockheed Martin. If the environment is your personal priority, your ESG portfolio will exclude businesses like the oil companies. Once you’ve eliminated all of the companies that are in conflict with your own ethical priorities, the companies that remain are your investment universe.
3. Positive Investing
Positive investing is the opposite of negative investing. Rather than avoiding certain companies the clash with your beliefs, you’ll proactively seek out those that support and promote your principles. For example, if the environment is your top priority, you’ll consider companies that produce goods and services that clean up the environment. Clean energy companies that produce wind and solar energy, for example, might be candidates for your ESG portfolio. If supporting workers is your area of interest, you’ll want to screen for companies that pay living wages, offer family benefits and allow unions, for example.
4. Thematic Investing
Thematic investing isn’t unique to ESG, but it’s easy to integrate with the ESG universe. Thematic investors select a certain area of the market that they wish to invest in; ESG investors take that one step further by only selecting from ESG-type investments. Themes that are common for ESG investors include clean energy, female leadership or strong ethical board governance. However, you can select any theme that appeals to you, then form a list of companies meeting those requirements.
5. Impact Investing
Impact investing is more of a direct way to direct your ESG dollars. As an impact investor, you’ll support companies that are actually physically doing things to make the world a better place. For example, you might choose to only invest in companies that run homeless shelters, build low-cost housing or undertake some other socially progressive business. Although this investment universe is smaller, investors can feel as if they are directly contributing to improving the world.
6. Investing in Individual ESG Stocks
Investing in individual stocks is a way that investors can select specific ESG companies that they want to own. This way, ESG investors don’t hand over their investment selections to fund managers or others who might not fully represent an investor’s wishes. With the proliferation of zero-commission online brokers, buying individual stocks has never been easier for investors. Some brokers also allow fractional share purchases, meaning even if you start with a limited amount of money you can build a diversified portfolio of individual stocks.
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7. Investing in ESG Mutual Funds
If you’d rather hand over the management of your ESG investments to a professional, buying shares of an ESG mutual fund might be the way to go. ESG funds have to explicitly define what their investment objectives are, and they publish their holdings at least quarterly. Thus, you can get a pretty good idea of whether or not a mutual fund is investing according to your own preferences by reading their literature. Just note that you shouldn’t buy a fund simply because of its name. Mutual fund companies often use fund names as marketing to draw in as many investors as possible. Check to make sure that a fund named “Environmental ESG Fund” actually invests in environmentally friendly companies you support.
8. Investing in Exchange-Traded Funds
Exchange-traded funds are a way to get the diversification of a mutual fund with the investment flexibility of an individual stock. As with stocks, most online brokers now offer zero-commission trading on ETFs, making them a low-cost way to make your ESG investments. One thing to note with ETFs is that many of them are sector-oriented, meaning they are specialized and typically need to be diversified with additional investments. For example, the iShares Global Clean Energy ETF invests only in companies providing renewable resources, while the iShares ESG MSCI USA ETF only buys companies that meet labor and human rights standards. You’ll likely want to mix these types of ETFs with more general ESG funds and/or broad market index ETFs.
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