The ABCs of ESG Investing
Are you considering dipping a toe into ESG investing—or maybe just diving all in? You’re not the only one. In 2019, investors poured $21 billion into environmental, social, and governance (ESG) funds. That’s a whopping number, yet it’s small potatoes compared with last year. According to MSNBC, ESG funds “captured $51.1 billion of net new money from investors in 2020.”
If you’re wondering if ESG investments are suitable for you, or just wondering what they are in the first place, this article gives a rundown of this popular investing trend, including thoughts on performance and potential risks if you decide to invest.
What Is ESG Investing?
Much like socially responsible investing (SRI), ESG investing allows you to align your portfolio with your values. A number of independent firms and research groups rate companies based on the following ESG criteria:
Environmental: This category includes factors such as a company’s carbon footprint, use of green technology, and treatment of animals.
Social: ESG ratings can be based on how a company treats its staff, adopts diversity and inclusion policies in hiring and advancing workers, and contributes to the community.
Governance (or corporate governance): This category covers a range of factors including whether executive compensation is reasonable, the company’s transparency with shareholders, and its history with regulators.
If these issues are important to you, then you may want to look into ESG investing.
Potential ESG Risks and Downsides
Aligning your investments with your portfolios may sound like a wonderful opportunity, but keep the following points in mind before you buy in.
First, there are no overarching ESG definitions or standards. What one agency may rate as acceptable, another may exclude altogether. As the article “What Is ESG Investing?” states: “How do you rate a company that pays a minimum wage of $15 an hour, a typical goal of ESG proponents, but also emits large amounts of CO2, which violates a different goal?”
Another downside is that some mutual funds or ETFs may be heavily concentrated in certain industries, such as technology. Although FAANG stocks may be great for your short-term returns, your portfolio may not be diversified enough to insulate you from market risk. Make sure to consider how any potential investment fits into your overall, diversified portfolio.
Finally, expense ratios for ESG funds tend to be higher than others. As an ethical investor, you may be OK with paying more so you can support ESG principles. However, as Forbes points out, “higher expenses ratios that aren’t associated with at least slightly higher performance may reduce your long-term returns.”
As with any potential investment strategy, do your research. And remember: Past performance is no guarantee of future results.
Speaking of performance …
How Do ESG Investments Perform?
Do an internet search for ESG investment performance, and you will find many articles touting their performance. We would say, as with anything, be cautious about hype.
Case in point: “Keeping ESG Investment Performance in Perspective” cites the triple-digit performances for the 10 best-performing ESG funds for the 12-month period through March 2021. Yet the funds started to decline in February even as the S&P 500 Index gained.
Perhaps the drop was a natural market correction to the enthusiasm of the prior year—it’s too soon to tell. But the point is that we don’t advise jumping on the ESG (or bitcoin, or NFT) bandwagon simply because it’s hot.
Ideally, your investment decisions will align with your overall risk tolerance, diversification needs, and long-term return goals. And with ESG stocks, the icing on the cake is that you get to invest according to your values.
Consider talking with an asset management firm to determine the role that these investments can play in your portfolio. Our fiduciary wealth management firm in Roseville and Folsom, California, helps clients determine the role of ESG investments as part of their overall financial picture and goals.
Schedule a complimentary, 15-minute call with a fee-only, fiduciary financial advisor today to discuss your personal situation.
This material was prepared by Kaleido Inc. from information derived from sources believed to be accurate. This information should not be construed as investment, tax or legal advice.
Parkshore Wealth Management is a family-owned, independent, fee-only Registered Investment Advisor serving the greater Sacramento area with an office in Roseville, CA. We partner with financially responsible individuals and families who are eager to take positive steps that will allow them to use their money to build the life they desire. The firm is led by Harold Anderson, CFP®, and Daniel Andersen, CFP®, both members of NAPFA, the country's leading professional association of fee-only financial advisors.