What Is ESG Investing?
ESG stands for Environmental, Social, and Governance. It is a logical extension to SRI - or Socially Responsible Investing - that surfaced in the 1960s. Although SRI has been around for decades, ESG is a relatively new approach based on sustainable investment principals.
How Does ESG Investing Work?
ESG investing (also known as impact investing) uses screens to identify investments that are beneficial to the environment, are for the social good, or are promoting good governance habits. A few of the factors include: climate change, independent governance, gender diversity, data security, business ethics, and human capital. Early SRI and ESG screens attempted to exclude stocks that did not meet requirements such as tobacco-free or firearms-free products and services. ESG investing has been growing in recent years with an influx of assets and investor interest due to a couple of different factors affecting the industry. First the world is changing and risks such as climate change, data privacy, and regulatory pressures are increasing in scope. Investors are also changing - asking more of their investments as many developed countries grow more liberal and care about the effects that their money have on the Earth.
How Pervasive Are ESG Investments?
All investments have an impact. Capital can be put to use for good or for bad, and the ways we spend and invest can have an outsize impact on society around us. ESG investing is becoming known as an investing strategy that minimizes reputational and operational risk. In the words of Henry Ford; “Quality means doing it right when no one is looking.” Growth in ESG investing is being fueled in part because it seems like simply the right thing to do. Investors today are more educated and informed on matters related to ESG investing and factors that go into creating the field. Although the number of mutual funds and exchange traded funds (ETFs) focused on the ESG theme has grown dramatically in the recent past, the assets invested in these vehicles is still at infancy levels.
Why Should We Consider ESG Investing?
A 2015 study by Morgan Stanley Institute for Sustainable Investing showed that ESG both increased portfolio returns and reduced portfolio volatility for 64% of the periods since 1990. Of the three factors (environmental, social and governance), the governance score has shown the strongest impact on performance. Bonds with a high governance score also suffered credit downgrades less often than those with a low governance score. It is estimated that there is now over 7 trillion dollars invested in socially responsible investments (roughly 1 of every 6 dollars). While ESG funds have proven to outperform the market on numerous occasions, for some investors, the fact that their investments are creating social good outweighs the financial returns that they may be putting off by investing in ESG.
Source: Can ESG Add Alpha?, MSCI.
Where Can We Learn More About ESG Investing?
ESG 101: What Is ESG Investing?; MSCI; 2018.
Sustainable Reality: Understanding the Performance of Sustainable Investment Strategies; Morgan Stanley Institute for Sustainable Investing; March 2015.
Socially-Responsible Investing: Earn Better Returns From Good Companies; Forbes; August 16, 2017.
Evidence links ESG performance to better investments; GreenBiz; January 10, 2018.
From ‘why’ to ‘why not’: Sustainable investing as the new normal; McKinsey & Co.; 2018.