Historically, most investors have looked for investments with a proven record of delivering competitive returns, without considering anything else. That mindset has changed significantly in the past decade as the global emphasis on sustainability has grown.
As a result, ESG investing is surging and now makes up 33 percent of total U.S. assets under management. ESG investors have moved beyond a strict economic perspective when it comes to investing and are increasingly emphasizing aligning their investments with their values. They want their investments to not only help fund their retirement years, or meet other financial objectives, but to make a positive difference from a social and environmental perspective.
However, with the amount of deception in this space, there’s a good amount of due diligence required to make sure these investments are truly impactful. In this short series, we’ll discuss how investors can properly vet companies who claim to abide by ESG guidelines, as well as the various impact investing vehicles available to successfully grow your money for good.
Beware of Greenwashing; It Isn’t ESG Investing
When it comes to ESG investing, many investors worry about falling victim to greenwashing. According to a recent study, nearly half (44 percent) of investors list greenwashed investments as their biggest concern.
Greenwashing occurs when companies use PR and advertising tactics to make investors and other stakeholders believe that they are more environmentally friendly and socially conscious than they really are. These companies might have an internal initiative or two that make their operations “less bad,” but they do little in terms of “active good” when it comes to minimizing their overall negative environmental and social impact. Their primary driver is to capitalize on the popular sustainability trend.
When It Comes to ESG Ratings, There Is No Gold Standard
In recent years, a variety of organizations have attempted to create ESG ratings based on various criteria to separate true ESG companies from those that might not be well-intentioned in their ESG efforts. However, these ratings are only as good as the quality of the data used. The ratings are typically heavily subjective in nature. Moreover, they can vary widely across industries, size of business, etc. As such, the problem is determining which ESG ratings provider to trust, if any.
There isn’t an agreed upon definition of what ESG criteria are today. A company that one mutual fund views as sound from a sustainability perspective might not pass muster for another fund.
ESG Investment Evaluation Requires a Quantitative and Qualitative Approach
When it comes to ESG investing, the use of traditional quantitative metrics isn’t enough. What constitutes meaningful impact for one investor mightt not for another. Quantitative metrics used to evaluate a company’s financial performance are still valuable in the world of ESG investing. ESG investors are certainly interested in financial numbers, along with social and environmental initiatives that can be quantified.
However, to feel confident that your ESG investment is having the type of social and environmental impact you’re after, you’ll need to develop a personalized qualitative analysis approach—in addition to any quantitative metrics a given investor finds useful—to use when considering potential ESG investments.
The qualitative judgment of what a company is doing needs to be the foundation of ESG investment analysis. Qualitative research seeks to answer “why” and “how” questions by reviewing a wide variety of publicly available traditional and social media content. It includes blogs, company reviews and required regulatory disclosures. Eventually, you can create your own narrative for qualitatively evaluating the performance of potential and current ESG investments.
So, What’s an ESG Investor to Do?
Developing your own ESG portfolio is a time-consuming endeavor. If you don’t want to spend the time doing extensive ESG research on your own, there are a few options: 1) ESG mutual funds and ETFs; 2) ESG portfolios created by digital advisors, aka robo-advisors; and 3) investing in companies that make direct investments in impact companies.
On the surface, an easy solution is to simply invest in the growing number of so-called ESG mutual funds and ETFs. However, that requires looking at the collective activities—many of which remain negative—of numerous companies within the funds.
Many so-called sustainable mutual funds and ETFs are nothing more than a collection of companies using greenwashing techniques. If you look closely at their portfolios, you’re likely to find oil and gas companies, gun manufacturers, junk food companies and companies that have gender inequality baked into their pay structures.
With robo-advisors, investors can list their ESG goals, investment criteria and risk tolerance and an investment portfolio will be built and managed for you by a computer program. The key step here is to make sure you study the robo-advisors methodology to make sure you agree with how certain potential investments are included or excluded from your portfolio.
Another potential solution is to invest in an investment holding company dedicated to directly investing in companies whose sole mission is to profitably address today’s social and environmental issues. If you find alignment with the values of the investment company, are comfortable with its methodology and believe its people are honest and transparent, you can save a lot of time in building a highly impactful ESG portfolio.
Navigating the ESG landscape can be tricky with the lack of uniform standards, but with proper research and/or approach, ESG investors can avoid greenwashing and ensure their investments make a difference.
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