Still wondering whether environmental, social and governance standards in investing, also known as ESG investing, is a trend that will eventually fizzle out? You can probably stop that now.
A recent report by PwC has shown that if anything, the global interest in ESG investing will accelerate to an even grander scale. By 2026, there will be $33.9 trillion in various ESG assets, representing 21.5% of total assets under management (AUM), or $1 for every $5 invested, PwC says.
Still wondering whether environmental, social and governance standards in investing, also known as ESG investing, is a trend that will eventually fizzle out? You can probably stop that now.
That may put ESG in the too-big-to-ignore category for most investors. But those numbers, as they say, are just the tip of the iceberg.
Just as investor demand for sustainability and social inclusion is increasing, companies are also increasing their efforts to comply with various ESG standards. Another recent report by PwC and Workiva reveals that 95% of company executives are now prioritizing ESG reporting as they await the final Securities and Exchange Commission ruling on climate-related financial disclosures, which could come this spring. In fact, 70% of the executives said they will proceed with compliance regardless of the SEC’s final ruling.
With global fascination with ESG investing on all sides, many investors are turning to their financial advisors to learn how to get started. As a member of the board of directors for the Certified Financial Planner Board of Standards Inc., I’ve witnessed this evolution firsthand. Let me offer some guidelines to get your journey in the world of ESG investing started off on the right foot:
— Identify your ESG values and priorities.
— Set clear ESG goals.
— Be on the alert for greenwashing.
— Check ESG scores of companies and funds.
— Do your own research.
— Seek advice from a specialist.
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Identify Your ESG Values and Priorities
When my clients ask me about getting started with ESG investing, my first response is to help them identify their passions and priorities. One of the key questions I ask is, “What issues and causes resonate with you?” I also ask, “What types of companies would you like to include or exclude in your investment portfolio?”
These are open-ended questions that get clients thinking and talking about what issues are important to them and how the investments they make can help them achieve their goals.
For some investors, ESG is all about avoiding companies that use fossil fuels or contribute negatively to climate change. For others, it is about investing in companies committed to alternative energy or plant-based innovations.
Still others prefer to focus on social issues. For them, labor standards, human rights, corporate social responsibility, and diversity, equity and inclusion (DEI) are priorities.
Then there are investors who are most concerned with a company’s governance structure. They prioritize financial policies, inclusion of women in top executive positions, executive compensation, and integration of employees in the company’s board.
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Set Clear ESG Goals
Before starting on the path of ESG investing, you should be very clear about the values you are most passionate about and the specific goals you want to support. This clarity is important because just as all ESG investors do not share the same values, all ESG funds are not attuned to every value that an investor may profess.
For example, the 1919 Socially Responsive Balanced Fund (ticker: SSIAX) is an ESG fund that prioritizes social factors (employment practices, social responsibility, human rights), while Shelton Green Alpha Fund (NEXTX) focuses on companies that reduce “environmental risks and ecological instabilities.”
And there are ESG funds such as iShares MSCI USA ESG Select ETF (SUSA), which are more focused on excluding industries during portfolio selection, such as those related to alcohol, tobacco, nuclear power and gambling.
Be on the Alert for Greenwashing
Once you are clear about your values and passions, you will then be in a good position to select the ESG funds or individual companies that align with them.
This is when I ask my clients, “What companies or sectors would you like to include or exclude in your investment portfolio?”
The most difficult task here is identifying whether a fund truly shares your values and passions. In fact, one of the troubles investors face is differentiating a true ESG company from one that is “greenwashing.” Greenwashing is a concept that describes companies that falsely overrate their environmental standards or impact to deceive stakeholders and ride the wave of ESG investing.
Even ESG funds themselves can be deceived by companies that are making unsubstantiated claims that would be characterized as greenwashing. If they include those company stocks in their portfolio, the funds are no longer aligned with your goals.
Check ESG Scores of Companies and Funds
So what, then, is the way forward?
ESG scores remain the most popular way for individual investors to evaluate the ESG compliance and performance of individual companies and funds.
Organizations that undertake this scoring create a group of standards through which they identify how well businesses measure up to ESG metrics. MSCI, for example, scores both individual companies and ESG funds based on well-defined metrics.
Rather than wandering in no-man’s land, you can begin your search for the companies and funds that align with your passions and priorities by sorting by the best ratings (AAA is the highest rating in MSCI scoring).
One way to reduce the risk of selecting the wrong investments is to use multiple ESG scoring platforms, such as Bloomberg ESG ratings; CDP, Refinitiv or S&P Global ESG scores; and FTSE Russell’s ESG data model, selecting only companies that have solid ratings on all the platforms.
[ READ: 5 Tactical Investing Methods for Advisors. ]
Do Your Own Research
ESG scores alone won’t tell you the whole story. So, you still need to individually research companies or funds, even those with strong ESG ratings, to be sure they are not greenwashing.
This research can include reading company ESG disclosures and sustainability reports, talking to their employees, making inquiries of their investor relations team, and reading reviews and articles about the company.
Another important thing to consider is that many ESG scoring sites use generic ESG metrics. If your values are more specific, you’ll need to select companies that do well based on those particular values (starting with more generic and getting down to the specifics).
For example, Bloomberg ESG ratings may focus on more generic ESG factors, while CDP (formerly Carbon Disclosure Project) scores highlight specific environmental impacts of the companies they evaluate.
Seek Advice From a Specialist
For most investors, ESG goals do not stand apart from other investment goals (retirement, financial independence, leaving an inheritance for the children, etc.). The tall order is knowing how to combine these goals to make the best investment decisions.
There are no easy answers here, and you will be better served talking with your financial advisor on the best way to proceed.
The chartered SRI counselor (CSRIC) professional designation is a groundbreaking certification in the fast-growing field of sustainable, responsible and impact investing (SRI) and is an industry-recognized credential encouraged by top financial firms. I received the CSRIC professional designation in December 2020.
No matter whom you bring on board to help you with your investment goals, many of the ESG dilemmas I’ve mentioned here can be solved with extensive research and clarity about what you hope to accomplish and the most appropriate investment vehicles to get you there.
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