What is sustainable or ESG Investing?
The deteriorating well being of our planet has people asking an important question: where can they invest their money and feel good about it? The answer is socially responsible investing (SRI), also known as ESG (Environmental, Social, and Governance) investing.
What is ESG Investing?
ESG stands for Environment, Social, and Governance , but what do these terms mean for you? When you make investment decisions, keep these three factors in mind so that you can identify and invest in companies that share your values. ESG investing means you, as the investor, evaluate more than what shows up in a financial analysis including:
- Environmental impact of the company including the preservation and protection of the natural environment.
- Social responsibilities within the company including how they interact with other suppliers, clients, and their own community.
- Governance practices within the company including how they represent diversity on their board or in their operations, conduct themselves in leadership roles and how they uphold shareholder rights.
ESG investing can also be thought of as ‘Sustainable’ investing. Socially responsible investors believe these kinds of sustainable practices will ultimately support long term growth of a company and thus provide good returns.
ESG investments can take many forms, but common choices are ETFs (Exchange Traded Funds) or mutual funds. Both of these account types act as a ‘basket’ for securities, including stocks and bonds. If you’re an ESG investor, you can choose one of these investment baskets, and make sure it houses securities that are socially responsible.
Whether it’s an ETF or a mutual fund, ESG investors want their money to back companies that consider more than their bottom line. The financial industry has heard this call and made an increased effort to outline ESG investing guidelines like the Principles for Responsible Investing (PRI).
The Growth and Performance of ESG investing
The term ESG investing was first coined in a study called “Who Cares Wins” in 2005. Since then, there has been an increase in the amount of money being invested in ESG funds. According to Morningstar data, 2019 was a record year with almost $20.6 billion dollars sustainably invested. This was four times as much as 2018. This is predicted to increase in the coming years as investors consider the impact of their money on our world.
Not only is ESG investing on the rise, but so are the returns. In a study comparing the annualized returns of high and low ESG portfolios, the high ESG portfolio outperformed the low portfolio on a regular basis.
How is ESG applied to the investing process?
ESG can be applied to the investing process in one of three ways: exclusionary screening, thematic investing or ESG integration.
An exclusionary screening is most often done by your financial advisor. An exclusionary screening removes investments from your portfolio that don’t align with your beliefs.
Originally, this was put in place as an option for individuals who did not want to support certain industries like Tobacco or Gambling. Now exclusionary screening has become more popular for investors who want to avoid owning any stocks that are connected to fossil fuels or companies with corrupted business practices.
Thematic investing is a long term investment strategy. Just like its name implies, your investments follow a theme over the long term. For example, for ESG investors, themes could be
- Clean energy, or
- Reducing poverty
Investing using a theme requires serious research of both the companies and the projected performance to make sure you aren’t taking on too much risk.
The PRI defines ESG integration as “the explicit and systematic inclusion of ESG issues in investment analysis and investment decisions.” This means there is a holistic analysis of a company’s practices before investing.
If the heavy analysis required in ESG integration is overwhelming, we recommend you start with ESG ETFs. They have already been vetted for specific sustainable practices and can be an easy place to start. Finch offers ESG ETFs to help you invest with purpose.
What does this all mean for you?
ESG investing means that you get to integrate your social beliefs into your investing practices – and help support companies that are making a change. It looks at more than typical financial analysis and considers the positive (or not so positive) impact of business practices on our earth. If sustainability is important to you, consider investing with Finch.