As environmental and social justice matters continue to make national headlines, you may be wondering if your financial investments align with your personal beliefs and values.
In recent years, the concept of socially responsible investing gave rise to the practice of Environmental, Social, and Governance (ESG) investing, which uses those guidelines to build a sustainable and ethical portfolio. Potential investments are screened for a variety of factors in each category to ensure that investments are made in companies whose leadership has demonstrated through ethical practices and policies that they care about people and the planet. Like all investing, there are both pros and cons, and it’s important to work with a financial company or advisor who is transparent and trustworthy when deciding if and how to begin ESG investing.
- What kinds of criteria are considered when screening for ESG factors?
Since Environmental, Social, and Governance investing is still a relatively new concept, there is no standardized definition or regulation to apply consistently across the financial industry. Several organizations are working to develop guidelines, but they are not a part of required financial reporting yet. This means that whatever company you’re investing with is determining their own criteria for screening the Environmental, Social, and Governance impacts.
When it comes to the environmental aspect of ESG investments, considerations often used for screening potential investments are: energy efficiency and usage, carbon emissions, pollution and waste disposal, animal testing, deforestation and other environmental degradation. For social elements, screening may account for: customer satisfaction, data usage and privacy protection, gender and racial diversity in hiring, employee working conditions, and community philanthropy. Governance relates to how the company is managed and led. Are stakeholder interests considered in board decisions? How are executives compensated compared to employees? Has the company engaged in any illegal acts? Does the company lobby ethically or seek to obtain political favor through seedier fashions? If you’re interested in an ESG portfolio, it’s important to speak with your financial advisor about what you want to avoid investing in and ask for their specific screening methods. Remember that there is no standardized definition of ESG investing yet, so understanding the approach of your investment adviser or an investment vehicle you have chosen is important to be assured that your investments align with your expectations.
Vision Capital’s Environmental, Social, and Governance portfolio was built using the financial community’s Global Industry Classification Standard (GICS) to screen for and exclude investments in defense, commodity chemicals, fertilizers, agricultural chemicals, metals and mining, as well as oil and gas companies. Our Investment Team then makes further adjustments based on findings during its normal course of research of a company.
- What are the pros and cons to Environmental, Social, and Governance investing?
The biggest pro of ESG investing is that you’re putting your money where your mouth is and prioritizing your value system. You’ve determined which issues are important to you and your investments reflect those priorities. As an investor, you are penalizing companies whose value systems don’t align with yours and rewarding ones that do. You may feel like a small fish in a big pond but consider that a 2018 Morgan Stanley survey found that more than $1 in every $4 under professional management is invested in some type of ESG portfolio. Globally, that represents more than $22.8 trillion dollars! Long term and with enough participants, real social change can be brought about by investing in ESG strategies.
Potential downsides to ESG investing are a narrower list of investment options, performance variance, and sometimes higher fees. Whether we like it or not, non-ESG companies – or even potentially unethical companies – often deliver great investment performance by focusing on increasing shareholder value, regardless of ESG factors. Investors normally seek to receive the highest possible return, but if you choose to have a portfolio that excludes companies based on ESG factors, you may have to accept a lower rate of return in exchange for aligning your investments with your values. That’s not to say ESG strategies always have lower performance, but it’s something to keep in mind. If defense companies are booming, for example, and your portfolio excludes defense, you risk not earning as much as some standard benchmarks. Fees for ESG investments may also be higher than for standard investments because there is a smaller pool of appropriate investment options and extra research is required by investment managers to screen out companies.
- What should I look for if I’m interested in ESG investing?
Decide what types of companies and industries you want to avoid and/or the ethics you require from the companies you invest in, and then reach out to your financial advisor to see what criteria they use to screen investments for their ESG portfolios. Ask questions to understand how they would build your portfolio, look at their historical performance, and get clarity on the fees you can expect (both the fees related to their management and the charges that come from specific investment vehicles, aka expense ratios).
The main purpose of socially conscious investing is to make you feel good about what you’re investing in, so be sure to work with an advisor with which you feel comfortable and trust to invest your money in alignment with your values. If you don’t work with an advisor, there are many online companies providing ESG options on their automated robo-platforms. However, it’s always important to consult a professional, such as a CERTIFIED FINANCIAL PLANNER™ or tax advisor, before making changes to your investments or starting to invest for the first time.