What Is Environmental, Social, and Governance (ESG) Investing?
by Joanne Castendyk
Environmental, social, and governance (ESG) investing refers to a set of standards used by investors to better align their capital investments with their core values. Unlike Socially Responsible Investing, which excludes companies that produce products like alcohol, tobacco and guns, ESG investing includes all sectors of businesses based on how they run their business, not based on what goods or services they sell.
As evidenced by the growing popularity of ESG funds, investors have become frustrated with news about plastic in our oceans, pollution in our air and ground water, environment disasters caused by industry, lack of diversity in the board room and poor treatment of employees, customers, and suppliers by major corporations. Bloomberg Intelligence estimates that based on current trends, EGS assets may hit $53 trillion by 2025, accounting for more than one third of assets under management.
From that perspective, no wonder people want to invest in companies that operate in a sustainable way. This focus on sustainable operations has translated into solid fund performance and investment returns that are comparable to their non ESG benchmarks.
Investment firms set their own screening questions and standards when building an ESG fund. This example of screening questions is from Boston-based Trillium Asset Management:
1) Does the company publish a carbon or sustainability report?
2) Do they limit harmful pollutants and chemicals?
3) Do they seek to lower greenhouse gas emissions and their CO2 footprint?
4) Do they use renewable energy sources?
5) Do they reduce waste?
1) Does the company operate an ethical supply chain?
2) Do they avoid overseas labor that may have questionable workplace safety or employ child labor?
3) Do they support all forms of diversity?
4) Are policies in place which protect against sexual misconduct?
5) Are employees paid a living wage?
1) Does the leadership team consist of diverse team members at the Executive Level and on the Board of Directors?
2) Is the company transparent in how they operate?
Based on this type of screening process, why wouldn’t you invest in an ESG fund? As with any product you purchase, some come at a premium. ESG funds typically cost more to invest in than an index fund. Screening standards are not uniform across all investment firms. The top holdings of many ESG funds are often the same top holdings you’ll find in an index fund.
As an example, here is a list of top 10 holdings for a highly rated ESG Fund with an expense ratio of .78: (I won’t dive into the expense ratio cost analysis but know this is an expensive fund to invest in)
Microsoft, United Health Group, Amazon, NVIDIA, Alphabet (Google) Class A, Danaher Group, Intuit, American Tower Corp, Thermo Fischer Scientific, Visa
Here is a list of the top 10 holdings for an S&P 500 index fund with an expense ratio of .03%:
Microsoft, United Health Group, Amazon, NVIDIA, Alphabet (Google) Class A shares, Alphabet (Google) Class C shares, Tesla, Berkshire Hathaway, Exxon and, Apple
It may seem obvious that Exxon wouldn’t be in the ESG fund top holdings list, but less obvious as to why Tesla is not.
The key takeaway is that ESG funds are getting better all the time. These screening questions exist to hold companies accountable for their actions. Consumers want to put their money where their values are. However, just like with any more expensive product, do your homework, and make sure the ESG fund you’re buying meets your own personal screening standards and is worth the premium you’ll pay.