Embracing Sustainable Investment Practices with ESG Investing
Earth Day (Apr. 22) raises awareness around issues impacting the Earth. This year’s theme, “Invest in Our Planet,” focuses on engaging governments, institutions, businesses, and citizens to be more accountable for actions that affect the health and sustainability of our planet. Investors can play a significant role through Environmental, Social, and Governance (ESG) investing. Under the premise that “money changes everything,” you can use the power of your investment money to create positive change by investing in companies with better management of ESG factors.
What Is ESG Investing?
ESG investing is an investment strategy that accounts for a business’ environmental and social risks. It has become very popular in recent years, especially among investors worried about climate change and social justice issues. ESG investment strategy includes evaluation of the following factors:
- Environmental: Companies inevitably affect the environment and can develop policies that minimize or neutralize the negative effects or produce positive effects in areas such as carbon emissions, water usage, green energy, pollution, and waste management among others.
- Social: Companies also impact our social environment, or the relationships it has with people and institutions in their community. That influence is demonstrated through diversity and inclusion policies, hiring and labor practices, workplace safety, and philanthropy.
- Governance: Companies have an internal system of practices, procedures, and controls for decision-making, governing itself, and complying with the law. Governance includes matters such as board diversity, executive pay, business ethics, competitive fairness, and financial processes.
Benefits of ESG Investing
ESG investing is a popular investment trend, but it’s not just a fad, as its market share has been steadily growing for decades. ESG assets now represent an estimated $4 trillion, a third of total global assets under management. This sector is only expected to grow as concerns about climate change, social justice, and governance practices become normalized.
- Growth Performance: The ESG investment strategy has proven to be not only better for the environment and our communities but has seen remarkable growth in return over the long-term. It has also proven more resilient during market contractions than other stocks on the S&P 500 index.
- Lower Risk: ESG investing can also help lower investor risks, like the long-term impacts that climate change will have on businesses. Increased demand for ESG investing in turn demands more reporting transparency about systemic risks. As a result, institutional investors and advisors have access to the information needed to make sounder investment decisions and recommendations.
The first step with ESG investing is to identify your passions and your investment priorities. What issues and causes resonate with you? What types of companies would you like to include in your portfolio? What specific changes would you like to see with your investments? There are also funds that focus on excluding industries during portfolio selection, such as those related to alcohol, tobacco, nuclear power, or gambling. The following steps will help you get started with ESG investing:
- Set clear investment goals. It is important to set clear investment goals and prioritize the values you are most passionate about. All ESG investors and funds do not share the same investment strategy. Make sure your portfolio manager or investment advisor is investing to support your values and objectives.
- Be on the alert for greenwashing. One of the most difficult ESG investing tasks is identifying whether a fund truly shares your values and passions. Investors often face differentiating a true ESG company from one that is “greenwashing” or falsely overrating their environmental standards or impact to deceive stakeholders.
- Check ESG Scores. ESG scores remain the most popular way for investors to evaluate the ESG compliance and performance of companies and funds. One way to reduce the risk of selecting the wrong investments is to use multiple ESG scoring platforms, such as MSCI, Bloomberg, CDP, Refinitiv, S&P Global, or FTSE Russell’s ESG data model, selecting only companies that have solid ratings on all the platforms.
- Do your own research. ESG scores alone won’t tell you the whole story. You will still need to research companies or funds to be sure they aren’t greenwashing. This research can include reading about the company, including their ESG disclosures, sustainability reports, and investment reviews.
- Choose ESG savings options. One of the easiest options for ESG investing is through a 401(k) or Individual Retirement Account (IRA). There are many ESG-oriented funds offered by major brokerages, such as iShares, Betterment, Fidelity, Vanguard, and BlackRock, among many others.
- Choose Personalized Indexing. Many employers have started offering a personalized indexing (PI) option with their pension and retirement funds. This custom-tailored approach ensures the funds align with their employees’ investment values, rather than relying solely on a fund manager’s judgment.
- Invest in an ESG EFT. Exchange Traded Funds (EFT) are baskets of stocks and bonds in which shares are purchased to reach specific objectives. They are like mutual funds, but they may be bought and sold at any time and depend on fluctuating market conditions during the trading period.
- Seek advice from a specialist. An overabundance of choices can make ESG investing overwhelming. A financial advisor that specializes in ESG can help you get started and ensure that your portfolio aligns with your values and goals. The Chartered Sustainable, Responsible, and Impact Counselor (CSRIC) professional designation is an industry-recognized credential encouraged by top financial firms.
Common Mistakes to Avoid
Before you deem ESG investing the new holy grail of investing, keep in mind that successful ESG investing requires more than just picking the best-in-class ESG funds or companies. ESG investing needs to be treated cautiously like any other investment decision. To avoid common ESG investment mistakes, look out for the following:
- Being too concentrated. The most common ESG investment mistake is making concentrated investments. You may even do this unknowingly. For example, when investing in an ESG fund, choose one with broad diversification. Some of the most popular funds have more than 30 percent allocated to a single sector, which places your investment at higher risk.
- Not diversifying. Having a diversified portfolio is still important to reaching your financial goals. This includes incorporating a balance of investment and liquid asset classes, even those that may not be ESG-optimized. Selecting a financial advisor specializing in ESG investing can help you navigate the nuances of investing in individual stocks and bonds that match your individualized investment objectives.
- Trying to do it all. What if you want to invest in all the ESG factors? While it would be great to align your investments with your morals while still outperforming and changing the world, applying too many filters can significantly reduce available investment opportunities and could lead to lower performance. Prioritize one objective and find a manager who you believe can execute on that one thing well.
The DFPI regulates investment advisors and financial services providers. To see if your investment advisor or brokerage is licensed, use our online Licensee and Service Provider Directory. If you have a question about evaluating an investment advisor or financial service provider, contact us at Ask.DFPI@dfpi.ca.gov or by calling toll-free at (866) 275-2677.