What’s ESG Investing, and How Do I Know if it’s Right for Me?

What we’ll cover:

• Environmental criteria consider how a company handles conservation and protection of the natural environment
• Social criteria look at the relationships a company has with their employees, customers, communities, and more
• Governance criteria are focused on how a company runs itself

Diversity. Climate change. Fair pay. These socially-minded topics (and more) have been on a lot of our minds lately. So it’s perhaps no wonder that they’re also coming up in investing, too.

Whether you’re a well-seasoned investor or you’re considering dipping your toes in for the first time, you may have heard of ESG investing. Particularly in the last few years, ESG investing has been increasing in popularity as investors realize profit and good business practices don’t have to be mutually exclusive.

(In fact, in 2020 so many dollars were invested in ESG ETFs that the sector officially doubled in size!)

Sometimes referred to as “sustainable investing,” ESG investing is about pursuing profit and a better world.

What is ESG Investing?

“ESG” stands for three broad categories investors can use to evaluate companies: Environmental, Social, and (corporate) Governance.

We’ll get into the details later on, but as a brief overview: Environmental criteria look at how companies perform as stewards of nature, while Social criteria look at how companies manage their relationships, including those with clients, employees, suppliers, and the communities the company is a part of. The Governance aspect considers how companies run themselves, looking at factors like executive pay, shareholder rights, audits, and so on.

ESG investing could be a good fit for you if you want to use your money to invest in and support companies that align with your values.

Now of course, each of those categories covers slightly different factors. And fund managers and financial institutions all have their own way of evaluating companies based on ESG factors. For example, one institution might have an ESG offering that avoids exposure in industries that are perhaps considered “sensitive sectors," like coal, tobacco, firearms and so on.

And regardless of what criteria are followed, that’s not to say that if you invest in an ESG ETF that every single company in the ETF will follow ESG criteria.,

ESG investing doesn’t have to mean sacrificing returns in order to align a portfolio with your values. Fund managers offering ESG investing options will take returns into consideration as well when evaluating an investment.

If a financial advisor for an ESG investor is comparing two funds as potential investments, and one fund has an ESG overlay in their investment process, all things being comparable, they might choose the ESG ETF.

ESG Factors

Now that you know a little more about what’s behind the name “ESG,” let’s dive into some specifics. Here’s what companies focus on when they try to hit each category.

Environmental Criteria

When it comes to the Environmental aspect of ESG investing, you’re likely looking at companies with a focus on conservation and protection of the natural environment.

Investors considering a company’s environmental criteria may look at how the company handles:

• Air emissions and air quality
• Energy efficiency
• Preservation of natural resources
• Waste management
• Land use
• Water scarcity
• Use of hazardous materials
• Pollution
• Treatment of animals

Social Criteria

The Social aspect of ESG investing looks at the relationships companies have with their employees, suppliers, clients and the communities they’re part of.

Some of the factors that fall under Social criteria include:

• Employee relations
• Customer satisfaction
• Data protection and privacy
• Providing equal employment opportunities
• What labor standards they follow
• Healthcare, education, and housing services they provide
• Production quality and safety
• Impact on the local community
• Volunteer work they participate in

Governance Criteria

And finally (drumroll, please) we make it to the final component of ESG investing, Governance criteria. When investors evaluate companies based on governance what they’re looking at are practices related to an organization’s leadership standards, shareholder rights and risk controls.

That could include:

• Board diversity
• Voting rights
• Ethical business practices
• Auditing
• Account and tax transparency
• Political contributions
• Executive pay versus employee pay

Positive and negative screening for ESG investments

There are two main ways to screen potential ESG investments: negative screening and positive screening. We’ll start with negative screening, which was actually one of the earliest methods used by socially responsible investors.

Essentially, negative screening means excluding companies that don’t align with an investor’s morals or values. For instance, when choosing stocks, an ESG investor may choose to exclude any company that tests on animals or those in industries like alcohol or tobacco products.

While negative screening has been historically used by ESG investors, positive screening has become popular lately as well.

It might be a good idea to prioritize what criteria are most important to you, and seek out companies/ETFs that follow those specific factors.

As you may have inferred, positive screening seeks out companies that align with their values, as opposed to excluding companies that don’t.

Now before you rush to your broker and ask that ESG ETFs be added to your portfolio immediately so you can align your investment dollars and your values, keep in mind that it’s not guaranteed companies successfully hit EVERY SINGLE piece of criteria when it comes to ESG investing.

So it might be a good idea to prioritize what criteria are most important to you, and seek out companies/ETFs that follow those specific factors.

Who’s ESG Investing a good fit for?

Unsurprisingly, the majority of folks interested in ESG investing are going to be socially- and environmentally-conscious investors, those people who believe their investment objectives and personal values can actually coexist.

ESG investing could be a good fit for you if you want to use your money to invest in and support companies that align with your values.

Of course, realistically you also probably want to be able to see some returns. While there’s been debate over the ability of ESG investing to really turn a comparable return compared to non-ESG investments, 2020 has largely made the point that it can.

Especially if we consider what a volatile year 2020 was for investing at large, ESG investments did pretty well! By late November 2020, year-to-date, 40% of ESG investments were in the top quartile for performance. So hopefully, for those interested in ESG investing, you are looking forward to a bright future ahead!