The previous decade produced 7 of the 10 hottest years in history. Extreme weather is happening more frequently, ranging from wildfires in Australia to Texas declaring emergency after recording record low temperature. Apart from climate change, there is a rise in racial and social discontent among people as inequality deepens across society.
Many governments and altruistic individuals are doing their best to combat this. What else can we do as individuals?
What if there was a way for investors like us to do our part, make our world a better place AND generate high returns for our investment portfolios at the same time?
Now you can do your part with ESG investing.
What is ESG Investing?
ESG stands for Environmental, Social, and Corporate Governance. ESG investing is an investment strategy that considers a firm’s impact on the environment, its social aspects, and how it is governed.
Such issues include climate change, gender diversity, and many more. Investors who adopt such a strategy share the goal of maximizing financial return while doing good for the planet.
Source: unpri.org
Environmental
The environmental aspects of ESG accounts for multiple factors in which a company is impacting the planet in both positive and negative ways. These include but are not limited to:
- Greenhouse gas emissions
- Water conservation
- Recycling and disposal practices
- Green infrastructure
- Incentives for employees to adopt a green lifestyle
Social
The social aspects accounts for people-related elements of a company.
It looks at how its employees are treated, how a company handles its customers and suppliers, and also how the company affects the sociality as a whole. These include but are not limited to:
- Employees’ salary, benefits and training
- Friendly customer service
- Ethical supply chain source
- Diversity and inclusion of its workforce
- Working culture
- Public stance on social justice issues like human rights etc
Governance
The governance aspects consider the strength of the board of directors as well as how shareholders are treated. These include but are not limited to:
- Executives’ compensation (Is it justifiable and tied to metrics that promote future growth for the business?)
- Diversity of the management team
- Conflict of interest arising from the board of directors’ interest in other companies
- Transparency of the companies’ dealings and financials
- Treatment of Shareholders
Why use the ‘ESG investing’ framework?
There are 2 main reasons why investors are using this framework.
1 – Create a more sustainable world
By investing in companies that have sustainable practices, it not only encourages companies to continue these practices, it also pressure companies with ethically dubious practices to change.
2 – Attractive financial Returns
This may not be the most intuitive but there are studies that show ESG stocks could allow investors to achieve a better risk return and even outperform the market.
ESG stocks tend to outperform the broader market because they possess certain positive attributes that are more likely to lead to future growth for the company.
For instance, a diverse workforce that is well treated could produce diverse opinions. It could also result in a more hardworking and motivated workforce. This contributes to better financial results for the companies which translates to higher returns for investors. The asset management start-up Arabesque found that S&P 500 companies in the top quintile for ESG outperformed those in the bottom quintile by more than 25% between 2014 and 2018.
In addition, ESG focused companies’ stock prices were also found to be less volatile.
In another study done by S&P Global Market Intelligence, out of 26 ESG funds, 19 outperformed the S&P 500 ETF. Even the worst performer of 2020, the Parnassus Endeavor Fund, returned 17.7%. This strong performance has been supported by the heavier weightage in large technology company stocks which is a rather common trend as many of these technology companies coincide with ESG investing goals.
3 – ESG investing forecasted to hit $53 trillion by 2025
According to Bloomberg, ESG assets are due to hit $53 trillion by 2025.
Although the current inflationary environment has slowed down the growth of ESG, with the first occurrence of net fund outflow reported in May 2022 (since 2018), forecasts for the growth of ESG investing remains strong.
ESG vs Impact Investing vs Socially responsible investing
Apart from ESG investing, you may have heard of frameworks like “sustainable investing” and “impact investing”. While they are often used interchangeably, there are some key differences.
ESG investing
ESG investing looks at the company’s environmental, social, and governance practices alongside traditional financial analysis. While there is an overlay of social consciousness, the main objective of ESG investing is the financial performance of ESG companies.
Impact investing
Impact investing takes it even further. Financial performance is secondary to the impact investor.
Instead, the main objective is to help a business accomplish specific goals that are beneficial to society and/or the environment. While investors could still generate certain returns, this is more often than not an unintended consequence.
Socially responsible investing (SRI)
SRI investing goes one step further than ESG by actively eliminating or selecting investments according to ethical guidelines, personal beliefs, and/or religion.
SRI investors aim to balance returns generation and business practice principles. Even if a company could provide a high return, an SRI investor may choose to skip it.
Some industries SRI investors tend to avoid include alcohol production, defence manufacture, gambling industry, and fossil fuel companies.
3 reasons why you should consider ESG investing
1 – Better returns
As mentioned above, ESG investing could potentially generate higher risk-adjusted returns for investors. Companies that have committed to sustainable business practices have proved to do better than their peers.
Compared to the S&P500, the iShares Trust ESG MSCI USA Leaders ETF has done pretty well over the last 5 years.
Source: TradingView
2 – Growing interest in sustainability
Firstly, there has been more support on the ground with regards to environmental and social concerns from the people. We are seeing more environmental and social movements urging governments to make significant changes.
From the image below, we could also see a rise in searches for ESG investing over the last 5 years as the public becomes more aware and interested in the field.
Apart from individuals, firms are doing more too.
With greater interest from the public, firms like Surbana Jurong Group have capitalised on the sustainability trend to raise cash while doing good for the environment. Recently Surbana Jurong Group has issued a $250 million sustainability linked bond which was oversubscribed more than 6x. Such bond ties the company to certain sustainability targets where one of them is to achieve net-zero carbon emissions at its campus by 2030.
Outside of Singapore, we even have major oil company like Shell undergoing a restructuring process. The company has ventured to cleaner ways of generating electricity like ethanol, offshore windfarm, solar and also hydrogen. It aims to be a net-zero emissions energy business by 2050, a rather ambitious goal for a traditional oil company. Nonetheless, this shows the strong support from firms to move towards a more sustainable business model.
Last but not the least, governments around the world are doing more.
In Singapore, the government have announced more concrete plans to address climate change. Some of these initiatives include phasing out ICE cars in favour of EV and also quadrupling our solar energy deployment to 1.5-gigawatt peak by 2025.
In the US, the Biden’s administration has also committed to fight climate change with the United State re-joining the Paris agreement on his first day.
With the growing interest, we have seen a steady increase in assets of sustainable funds globally. Global assets climbed 29% to USD 1.65 trillion in the fourth quarter of 2020.
In the short run, ESG investors stand to benefit from the net inflow of funds into this sector resulting in inorganic growth.
3 – Make a positive impact with your wealth
For a long time, it has been hard for individuals to make a positive impact due to limited finances. However, with ESG investing, you can do your part now while generating returns for your retirement.
Green technology, driverless cars and mobile payments are just some industries that have huge potential and are also great for the environment.
How to invest in ESG companies?
Well, there are a few ways. You can choose to buy an ETF/Fund that contains a basket of ESG companies or pick them yourself.
ESG Investing ETFs
There are many ESG ETFs out there and most have different ways of seeking ESG companies to invest in.
Source: etf.com
For more details, do take a look at their prospectors which will tell you how they select ESG companies.
Here’s an ETF that you may consider.
iShares MSCI USA ESG Select ETF (NASDAQ: SUSA)
This ETF seeks to track the investment results of an index composed of U.S. large and mid-capitalization stocks of companies with high environmental, social, and governance performance relative to their sector peers.
Its top holding includes popular names like Microsoft and Apple.
Individual ESG stocks
If you want to get better returns, you can consider picking ESG companies yourself. Here are some steps to find out more.
1 – Sustainability Report
First up, you can take a look at the company’s sustainability report which would show you what the company has been doing.
2 – Media report
Next, look at media reports to keep up with the company’s business affair and also the way they treat their employees. Another great way to gauge employees’ treatment is to read employee reviews on websites such as Glassdoor.com.
3 – Research Tools
Apart from that, there are some tools like Sustainalytics and MSCI ESG ratings which you can use to find ESG stocks. (Read more about ESG Ratings here)
Sustainalytics is a global leader in ESG research and ratings, that is owned by MorningStar.
This tool allows investors to compare the ESG performance of companies against their peers and across the various market.
MSCI is another company which provide ESG ratings of the company as well as the breakdown as to which components are doing well and those that are not.
Here are some highly rated ESG companies which you can start your research with:
- Nvidia (NVDA)
- Salesforce.com (CRM)
- Adobe (ADBE)
- Intuit (INTU)
- Microsoft (MSFT)
- Nike (NKE)
For more, here’re the top 10 MSCI AAA rated ESG ETFs.
Risks of ESG Investing
There’re always two sides to a coin. Here’re two major risks of ESG investing:
Lack of widely agreed upon standards.
This is a major risk of ESG investing. What defines a company’s ESG rating is highly subjective, depending on its reviewer. Different schools of thought would inherently produce varying grades across rating companies on the same company.
For example, do you think a fossil fuel company should be part of an ESG fund? One camp argues that as long as the fossil fuel company is the most efficient in its field, it is much more environmentally friendly and hence should be included. The other camp believes that no matter how efficient a fossil fuel company is, it is still a major contributor to climate change and thus should be excluded.
This sort of debate is the current challenge ESG investors are facing. While guidelines are starting to come in place as more and more investors start to gain interest in this investment framework, it would take time for a widely recognized standard.
Lack of Transparency
ESG ratings provided by 3rd party data providers like MSCI and Sustainalytics often rely on the company’s disclosures of their efforts to work towards the ESG goals. However, the problem is that most countries do not require companies to track their ESG performance.
The only information investors can get hold of are from their financial reports, which makes it hard to sieve out good and bad companies.
To make things worse, some companies even go to the extent to greenwash their operation by giving a false impression that they are doing good.
What am I going to do?
ESG investing is still at its early stage with guidelines still being ironed out. Nonetheless, there has been growing interest in such an investment style over the years.
Moving forward, I would continue with my usual routine of analysing a company with traditional metrics. Once that is done, I would compare these companies ESG score and favour the one that is ranked higher.
Let’s all do our part, else we may have a doomsday scenario as portrayed in the Snowpiercer ????
