Time to Read: 5 Minutes
ESG is one of the fastest-growing themes within the investment world, quickly gaining prominence across the spectrum of financial products from ETFs to specialized, custom strategies. The Forum for Sustainable and Responsible Investment reports that total U.S.-domiciled sustainably invested assets under management grew 42% between 2018 and 2020. They now represent 33% of the $51.4 trillion in total U.S. assets under professional management.
ESG strategies are now easier to deploy in investment portfolios than ever before, helping individual investors express their values in ways that can potentially help them meet their financial goals.
At BWM Financial, we are proud to now offer ESG alternatives to our traditional tactical models as well as a solution from Ethic Inc. which allows clients to create a customized portfolio aligning their investments with their values and desired impact. In support of these new offerings, here we explore the concept of ESG investing and provide an overview of how it works.
What is ESG investing?
ESG stands for environmental, social and governance—three factors considered alongside traditional financial research to evaluate whether a given company is potentially a good investment. ESG criteria are designed to select investments with the potential to perform well, by doing good.
Investors may be familiar with socially responsible investing (SRI). Around since the 1960s, SRI encompasses several different types of investing, including ESG. For both SRI and ESG, the fundamental concept is to analyze investments and companies by establishing various screens that determine whether the stock meets the investor’s criteria. SRI screens out investments that don’t meet certain criteria. Screens in ESG investing, on the other hand, are designed to actively identify companies to invest in that meet the given ESG criteria in addition to financial or other considerations.
By looking for investments that meet certain ESG criteria, investors are working at the company level. As a result, certain industries that might be excluded by an SRI screen, such as defense production, could be included in an ESG portfolio if they score well on environmental, social and/or governance criteria. (That said, ESG investors can still opt out of investing in certain industries.)
Breaking down the acronym
Of the three ESG components, environmental and social factors are usually most important to individual investors, as they connect most directly to personal values. For institutional investors, governance criteria play an important role. In theory, positive corporate governance practices are supportive of a better-run company that’s responsive to shareholders—characteristics which can drive better financial performance.
Environmental criteria focus on the extent to which the company is an active participant in helping to support sustainability. Positive examples would include companies supporting the move away from fossil fuels. For companies that are not actively promoting sustainability, the question is more about the impact of the business on the environment. This can include everything from carbon footprint and toxic chemicals involved in manufacturing processes to supply chain management.
Progress towards environmental and climate goals has recently been linked to short- and long-term economic growth. For example, a report from the Organization for Economic Co-operation and Development (OECD) found that combining climate and pro-growth reforms would result in a long-run economic output boost of 2.5% across the G20 in 2050, rising to 4.6% when avoided economic damages from climate change are included.
In the U.S., the proposed infrastructure bill incorporates fighting climate change as a pillar of the plan, featuring investment across a broad range of industries. This is intended to help meet 2030 climate goals, but will also rebuild key pieces of infrastructure while likely fueling significant economic growth. While the plan will undergo changes as it navigates the legislative process, the likelihood of it passing in some form is fairly high.
In the past, social criteria focused primarily on the treatment of workers. More recently, the focus has evolved into an understanding of how the company is structured and what the social impact is on the broader community. Companies that embrace diversity and work towards equality in all spheres—even becoming advocates for social good beyond their own hiring practices—are becoming the standard. Where companies used to avoid taking public stances on controversial topics, over the last year we’ve seen that companies taking a stand have been rewarded, even if those gains are just in reputation.
Corporate governance analysis is focused on a company’s board and management. Criteria include everything from executive pay to diversity in leadership and how responsive a company is to its shareholders. Issues such as transparency, privacy and data security also come into play.
The bottom line
ESG investing has moved well into the mainstream, gaining traction as an effective approach to identify attractive, ethical investments. For clients and investors who would like to incorporate ESG into their investment strategy, there are a myriad of options. At BWM, we have done the homework and are pleased to present our clients with excellent strategies to consider. Let us know if you have an interest in learning more!