Why Invest Sustainably?
ESG investing, which considers environmental, social, and governance factors like carbon emissions during the investment process, has been all the rage over the past year. Yet, it is more than a passing trend.
With wildfires in California and floods in Germany, climate change is increasingly visible. It is also at the top of the political agenda as the world prepares for the COP26 climate change conference in Glasgow. And, while governance has always been a priority for investors, the “S” in ESG has gained prominence with the rise of social movements like #MeToo.
Fueled by these trends, some investors, particularly millennials, don’t want to own stocks in fossil fuel companies or those with poor diversity track records. The goal is to punish businesses for “bad” behavior (despite the risk that less scrupulous investors step in.) On top of that, some investors want their portfolios to reflect their values no matter what, even if it means missing out on potential profit.
However, although the field of ESG investing is new, there is now ample evidence that ESG need not mean sacrificing profits. Multiple studies have shown that ESG investing can generate higher returns. A recent New York University review of over 1,000 studies on ESG investing and performance found that ESG stocks and funds not only outperform but also do so with less downside risk.
Of course, any investor should care about reducing risk, and you can look at ESG investing as a risk mitigation strategy. Environmental, social, and governance risks are financial risks. A company that continues to rely on extracting fossil fuels and does not have a Plan B, like investing in renewables, will be stuck with stranded assets. And a consumer business with no diversity in senior management is more likely to come up with tone-deaf marketing, leading to a consumer backlash.
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There Are Now More ESG Options Than Ever Before
Financial product purveyors have responded to the surge of interest in ESG. According to Morningstar, in 2020, there were 392 U.S. ESG funds with over $236 billion in assets, up 72% over 2019. 71 ESG funds launched in 2020 alone. However, it also turns out that some ESG funds simply rebrand without making material changes to how they invest. Morningstar found that in 2020 over 250 European funds reinvented themselves as “sustainable,” but many haven’t done much beyond selling a few controversial stocks. Stories like this lead to allegations of “greenwashing” or embellishing the “green” characteristics of a product for marketing.
In addition to ESG funds, there are over 12 robo-advisors with socially responsible options, most of them launched over the past two years. (Robo-advisors are online financial advisors that will build a portfolio and manage assets for you.) All the largest robo-advisors, including Betterment and Wealthfront, now offer some sort of impact, socially responsible, or sustainable portfolios.
Last but not least, three “green” banks launched in early 2021 alone, and Aspiration, the green neobank, just launched the first credit card in the U.S. that will plant trees every time you shop.
The Number Of Options Is Creating Confusion About ESG Investing
Despite (and because of) the growing number of ESG options, there is more confusion about ESG investing than ever before.
First, ESG investing is often referred to as socially responsible investing (SRI) or impact investing, which are not quite the same. SRI investing is mostly about excluding “sin” stocks in sectors like gambling and tobacco. Impact investing seeks to generate measurable outcomes, often through direct private investments.
Second, there are dozens of rating agencies that score stocks and funds on ESG factors without much agreement. Environmental, social, and governance factors can conflict, and people often care more about one of them. For example, Tesla is working on “solving” climate change by popularizing electric vehicles, but it usually gets poor scores on social and governance factors. So it’s unclear if it’s a good ESG stock or a bad ESG stock. If you only care about climate change, it is probably good, but not if you prioritize social and governance issues.
Third, some investors think that ESG investing is fossil-free investing, which is not the case. They are outraged when they find out that their ESG fund owns Exxon Mobil or another large oil and gas company. Some ESG funds are indeed fossil-free, but others still invest in energy stocks, though less than normal funds, to try to perform like the broad market.
Although more investors want to be sustainable or invest with impact, the proliferation of standards and options makes it hard to know where to invest. You can buy exchange-traded funds (ETFs), mutual funds, or stocks. You can put your money in a socially responsible robot-advisor portfolio.
Many human financial advisors are pitching themselves as ESG experts, too. You can even invest in clean energy startups on a crowdfunding platform. The problem is that many investors don’t know how to choose among these options or even what they are.
As the number of options available to investors who want to invest responsibly keeps expanding, we hop the field becomes more transparent and easier to navigate.
Editor’s Note: The opinions expressed here by Impakter.com columnists are their own, not those of Impakter.com.