The Informed Investor

ESG: A Real Thing or Passing Trend in Investing?

Randy A. Garcia, CEO

November 2, 2020

This is the first article in a series of four about ESG Investing.

Investing trends often appear quickly and fade just as fast. But an interesting one has come on the scene—and stayed. That trend is Socially Responsible Investing, or “ESG” (which stands for Environmental, Social, and Governance Investing).

And this is good news for most investors. The idea that you can benefit financially while doing good things in the world is compelling.

The data shows that many people all over the world are enthusiastic about that concept; people have invested record amounts into these sustainable investment funds this year. According to Morningstar, over $71.1 billion globally was invested just between April and June of this year, pushing total assets under management in ESG funds to over $1 trillion.[i]

That is even more dramatic given the popularity of “passive” investments, meaning those that simply try to mimic the holdings and performance of an established index. Instead, these ESG funds require an active manager, since researchers need to find and verify that companies uphold these ESG standards.

More Than Just a Pretty Face

No one in their right mind is likely to argue that doing good in the world isn’t important, but can it benefit investors? More good news: research suggests that socially responsible investing is profitable. A study by Blackrock showed that year to date (between January 1 and May 11, 2020, as of the study), 88% of ESG funds it studied beat their parent benchmarks.[ii]

That is just short-term performance data. However, other research looking at the long-term performance of a sample of 745 Europe-based sustainable funds showed that the majority of ESG strategies have done better than conventional funds over one-, five-, and 10-year periods. [iii]

Getting Noticed

With millions of dollars flowing into socially responsible funds, the business world cannot help but notice. Companies that adhere to strict ESG standards are being rewarded by more investment capital and higher stock prices, so that is definitely catching the attention of corporate executives.

And as more companies take notice, there is pressure on other firms to keep up. Therefore, it is likely that the growth of ESG investing will simply continue to increase.

COVID-19 Accelerating the Trend

The concept of sustainable investing started gaining ground in the early 2000s, but with the onset of COVID-19, the trend has steadily increased in popularity. Early ESG supporters had concerns that the pandemic would simply sideline these themes, with many businesses simply focusing on survival. Surprisingly, however, the ESG trend has instead caught even more attention, as the themes of climate change, response to the pandemic, and other factors take the spotlight on the world stage.

A survey by the Principles for Responsible Investment Academy (PRI) found that along with concerns about climate change, this year has brought about a surge in social themes.[iv]

These include concerns such as:

  • Occupational health and safety
  • Social safety nets to protect low income Americans from poverty and hardships
  • Worker protections
  • Responsible purchasing practices
  • Diversity
  • Digital rights and privacy

Financial Sustainability

There has been another surprising finding: the most socially responsible corporations can be the most financially sustainable organizations, too. Blackrock’s researchers found that during times the market fell in 2020, ESG indexes fell by less. Specifically, Blackrock’s work showed that 94% of ESG funds it studied beat their parent benchmarks during the volatile first quarter of 2020.[v]

This unique combination of sustainability along with resilience is, of course, encouraging even more investment.

Incorporating ESG into Your Portfolio

As a long-time wealth manager, I have been helping clients tailor their portfolios to fit their values for over 40 years. Now, doing so is easier, and more clients are definitely asking.

As an investor, you have a choice of incorporating socially responsible themes in several ways:

  • Finding mutual funds and exchange-traded funds (ETFs) that provide ESG-themed investments
  • Researching individual companies that meet certain ESG themes
  • Choosing your investments based on ESG ratings

When you do this research, remember that this is a relatively new field. There are funds and ETFs that carefully research, assemble, and monitor these investments, but there are some that simply try to capitalize on the trend. There are also ESG rating agencies, but they are dealing with information that isn’t standardized and a field that has no regulation.

So that means more care needs to be taken. If you are buying a fund or ETF, you need to look even closer at management (which you or your financial advisor should be doing already).

And as with all of your investments, fees and expenses always count. Because any ESG funds require research, you are going to be paying more in active management fees. Fortunately, the ESG industry is large enough that you can also screen for reasonable expenses.

And you or your financial advisor should always be monitoring investments, too, since a change in fund management may mean a different level of research, commitment to ESG principles, or other surprises that might impact your investment.

Finally, always use a fiduciary advisor who by law has to put your interests first. There is no use investing in ethical investments if you are going to get treated unethically in the process. (Learn more about the critical importance of hiring a fiduciary in my March, 9, 2020 blog entitled What is a Fiduciary Advisor and Why Do You Need One?)

Shaping Tomorrow’s World

With investors no longer having to necessarily make the choice of profit over doing the right thing, the forces at play may help shape our world for the better going forward.Whether it is focusing on lower exposure to fossil fuels or supporting better ESG corporate practices, the future looks brighter than ever.

 

[i] Riding, Siobhan. ESG Funds Attract Record Inflows during Crisis. 10 Aug. 2020, www.ft.com/content/27025f35-283f-4956-b6a0-0adbfd4c7a0e.

[ii] Sustainable Investing: Resilience amid uncertainty. 2020, www.blackrock.com/corporate/literature/investor-education/sustainable-investing-resilience.pdf.

[iii] Shrma, Abhishek. Majority of ESG Funds Outperform Wider Market over 10 Years. 23 Sept. 2020, technocodex.com/majority-of-esg-funds-outperform-wider-market-over-10-years/.

[iv] “COVID-19 Accelerates ESG Trends, Global Investors Confirm.” PRI, PRI Academy, 3 Sept. 2020, www.unpri.org/pri-blogs/covid-19-accelerates-esg-trends-global-investors-confirm/6372.article.

[v] Sustainable Investing: Resilience amid Uncertainty. 2020, www.blackrock.com/corporate/literature/investor-education/sustainable-investing-resilience.pdf.

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