Environmental, Social and Governance (ESG) investing has become a hot topic in the world of finance in recent years. What is this and is it a good idea? Here’s everything you need to know:
What is ESG investing?
ESG investing is “making investment choices that emphasize social and environmental responsibility alongside profits,” according to NPR. The investor evaluates potential companies based on how well they fulfill their environmental and social responsibilities, which summarizes the findings in an ESG score. Some factors that affect a company’s valuation are carbon footprint, level of diversity, and political contributions. More broadly, ESG investing means looking at “how a company serves all its stakeholders: workers, communities, customers, shareholders and the environment,” he explained Forbes.
ESG ratings are determined by research firms, explained Linda Zhang, senior advisor at online banking company SoFi and CEO of Purview Investments. “Rating firms tend to rely on multiple criteria to rate each of the individual E, S and G components.” Some notable ESG research firms include Bloomberg and JUST Capital. Individuals can also decide how they want to invest based on their own analysis and criteria.
“At its core, ESG investing is about affecting positive change in society by being a better investor,” said Hank Smith, Head of Investment Strategy at The Haverford Trust Company. He added that this form of investment implies that ESG factors improve the company’s bottom line. But ESG investing is not without controversy.
Why is ESG controversial?
The debate revolves around whether this is just another form of greenwashing. ESG investing is “designed almost entirely to maximize shareholder returns, which mistakenly leads many investors to believe that their portfolios are good for the world,” argued Hans Taparia, a clinical associate professor at New York University’s Stern School of Business, in New York Times. Companies like Meta, Alphabet and — “most strikingly” — BP and Exxon have “respectable” ESG ratings, Taparia said. Indeed Coca Cola Co. has been labeled an “ESG leader” even though its “single-use plastic production is responsible for more pollution than any other company in the world,” said The motley fool.
But that doesn’t mean ESG investing doesn’t have merit. Some research suggests that ESG investments may be more robust than others. Like Investopedia explained, ESG investors may be able to “avoid the blowups that occur when companies operating in risky or unethical ways are ultimately held accountable for the consequences.” The 2022 data also speaks to the robust nature of ESG products, which “managed to perform in line with the overall market” in a very volatile year while attracting new money, “a good sign for the future of responsible investing,” CNN concludes Business.
ESG investing is also a way to support causes like workers’ rights and climate action in your own way. Investors can “make sure they’re not investing in companies that exacerbate or contribute to these problems and would rather invest in those that champion leading ESG movements,” notes SoFi’s Zhang.
The key, as with any investment, is to do it responsibly.
How can I get into ESG investing?
Start by determining your personal ESG values as well as doing some research. Through a brokerage account, you can invest yourself in individual stocks or in ESG funds. Buying individual stocks is good if you have a specific company in mind. Check out their impact report, “which will highlight any sustainability or cultural initiatives they’ve implemented and how they’re tackling issues like carbon emissions.” NerdWallet said. But “funds can fill out your portfolio quickly and can instantly diversify your holdings,” adds the personal finance site. When investing in an ESG fund, there is an expense ratio to consider, which means “you may pay a slight premium to invest in funds that target ESG criteria,” on Forbes. That ratio isn’t as high as it used to be, explained Mike Walters, CEO of USA Financial, “but it’s still higher than the average for other funds.”
Sometimes it is difficult to determine what would be a good investment to start with. Newbies can enlist the help of a robo-advisor that will “build and manage investment portfolios based on your risk tolerance and goals,” at NerdWallet. Some examples include Betterment and Merrill Edge Guided Investing. If you use a robo-advisor, it’s important to research how the advisor makes investments because everyone will vary. But it can be a cheap and easy way to get into ESG investing without much knowledge or experience.
You can also hire an ESG financial advisor who can help you create a portfolio aligned with your values and financial goals.
Rachel Robashotti, founder and CEO of Adasina Social Capital, advises asking questions like, “What is the problem you care about or want to have an impact on? How do you measure this problem and your impact? And who are you working with to do that?” It’s also important to remember that investment alone isn’t necessarily enough to pressure companies to improve their behavior and that political action is needed to create significant social change, he said. Vox.