The Informed Investor
This is the fourth article in a series on ESG Investing.
First, in case you missed the previous articles, we will define ESG, also known as Socially Responsible Investing.
What Exactly is ESG?
ESG stands for Environmental, Social, and Governance Investing. This type of investing involves adding another screen or additional criteria when you choose investments. That means in addition to evaluating an investment’s financial metrics, you also evaluate a corporation’s or fund’s policies related to environmental matters (climate change and pollution, for example), social matters (such as diversity and ethics), and governance (style of leadership and transparency).
How Can You Incorporate ESG into your Investing?
There are many ways to use ESG strategies in your investment portfolio. These can range from simply adding this as an additional screen to your existing investment research process, to buying investments that were created specifically to focus on socially responsible strategies.
Here is an overview your basic options:
With individual stocks, you can either invest specifically in socially responsible themes (for example, buy stocks in the solar energy industry), or you can add ESG research as an additional layer to your current research. Just beware of the common pitfalls of ESG ratings, which can be very subjective and are not yet standardized.
Mutual Funds or Exchange-Traded Funds:
If you are looking for simplicity, the mutual fund and ETF industry has produced many options for those who wish to invest based on sustainability. However, you may pay additional management fees for these actively managed funds, so it is essential that you know exactly what you are buying (and what you are paying for them).
How to Start
With that background, let us take a closer look. How can you start integrating ESG into your financial planning and investment management strategy? Here are four tips.
- Always be realistic about ESG
Your first step is to realize what you are dealing with. In this case, ESG Investing is still a relatively new field. Yes, ESG ratings exist, but research has shown that these ratings are rooted more in opinion than in fact.[i] Ratings haven’t yet been proven over time, as they are based on short histories. Until there are regulations and required disclosures, researchers and rating agencies are doing the best they can with imperfect raw data. If you plan to use those ratings to help you make decisions, just be aware that they are still evolving.
Also, with significant money flowing into this arena, there is the warning that some may be trying to increase ratings any way they can. That means those corporations with a high rating may not be as socially responsible as they appear. This practice is known as “greenwashing” and is unfortunately quite common.
- Do not abandon—add
Based on the first tip, it is critical that you do not abandon ANY of your existing investment metrics, and instead add ESG on as a final screen. After all, your financial security still matters. No matter how much an investment may help the world, you need it to help secure your future as well. So treat ESG as a final screen after investments pass your other metrics, such as profitability, revenue growth, and risk.
Believe it or not, adding ESG as a screen may actually reduce your risk. A socially responsible firm with strong policies around today’s flash points may be less likely to be impacted by environmental, regulatory, or legal claims. Additionally, companies with strong social policies tend to be less likely to end up mired in controversial situations that can put investors at risk.
- Fees Still Matter
When growing your wealth, fees are critical. Because most ESG funds are actively managed, the fees will be higher than most passively managed funds. Be sure to select funds with reasonable fees; otherwise, those expenses could be a continued drag on performance.
Finding the Right ESG-Friendly Financial Advisor
When growing your wealth with any strategy, you need to avoid mistakes. That is why most people do best by hiring a financial advisor. But be careful, as there is so much at stake. Bad advice, like bad investments, can be harmful to your wealth.
So always be sure to look for the critical elements:
Fiduciary. Only a financial advisor that acts as your fiduciary is technically responsible for putting your best interests first at all times. There is too much at risk, so only work with those who agree, in writing, to act as your fiduciary advisor.
Experience. With investing, financial industry experience is critical. You are usually best served working with an advisory firm with decades of experience, not just a few years. Ideally, look for a firm that has helped clients navigate through many types of economic and market environments.
Support. To build and protect wealth properly, a financial advisor needs to understand and stay current with regard to your needs. Meeting annually is not enough. Look for a firm that meets with you quarterly so they can help you stay prepared and proactive for whatever the market throws your way.
Just like with the ESG ratings, many of the same concepts apply to finding the right advice. Look for a financial advisor that first meets all of these requirements, then ask about ESG knowledge. That can be the cherry on top.
[i] Doyle, Timothy. “Ratings That Don’t Rate: The Subjective World of ESG Ratings Agencies.” The Harvard Law School Forum on Corporate Governance, The President and Fellows of Harvard College, 7 Aug. 2018, corpgov.law.harvard.edu/2018/08/07/ratings-that-dont-rate-the-subjective-world-of-esg-ratings-agencies/.
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