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Most investors and companies see investing for the good of the world as a three-letter word: ESG—Environmental, Social, and Governance. The basic idea is for a company to respect the environment, improve the social level of its stakeholders (raise minimum wages, improve working conditions, and give back to society around them) and ensure that the firm’s own governance is smart, transparent and serving the interests of all stakeholders, not just major shareholders and C-suite executives.
That sounds like just the place you’d want to put your money, but it also raises some big questions for the novice investor:
- Can you really change the world—or even the behavior of a single company—with your own personal investments?
- How do you know what makes a legitimate ESG investment?
- Can you get the kind of returns you need to buy a home or send your kids (or your future kids) to college or to be able to retire and cover your expenses when you no longer can or want to work?
“I don’t think that putting your investment in an ESG fund alone will save the world,” says Ian Monroe, a lecturer in environmental science at Stanford University in Palo Alto, and the founder of Etho Capital, which has an exchange traded climate fund that invests only in stocks that have been extensively vetted for the contribution to reducing greenhouse gas emissions. “The extent of the tangible impact made by ESG investments remains a topic of debate,” says Ben Bakkum, an investment researcher at Betterment, the investing and savings app.
Still, Bakkum points to one powerful example of ESG Investments influencing corporate decision making. The Engine No. 1 Transform 500 ETF (Ticker: VOTE), which Betterment has made available to its customers as part of its socially responsible investing strategy, stunned the corporate world by winning a proxy battle against the current leadership of one of the biggest oil companies, persuading a coalition of shareholders to elect three of its own candidates to the board—the first ever climate-centered case for change.
“A really important part of the options available to investors is the ability to move our money where our values are…”
Engine No. 1 argued that the company’s share price was underperforming its peers because the company was unprepared for the transition away from fossil fuels. It nominated candidates for the board that would push the oil giant to embrace renewable energy. Against all odds, holding just .02% of the company’s stock, Engine No. 1 prevailed.
“But,” he adds, “a really important part of the options available to investors is the ability to move our money where our values are, and ESG funds can play a large role in that.”
“Every single cent counts,” says Anny Giavelli, a sustainable investment strategist at Ecofin in London, which offers its own ETFs and other funds focused on sustainability. The best way to make those cents count, says Giavelli, is by investing in funds that have active ESG strategies that align with the change you’d like to see in the world: close the male-female wage gap? Cut carbon emissions? Promote better wages for farm workers? Save the world’s water resources? There’s a fund for that.
While you could pull out all kinds of socially responsible investing indexes and do your own analysis to see how companies’ claims stack up against some of the major ESGs and benchmarks, with nearly 6,000 companies trading just on the New York Stock Exchange and the Nasdaq, and the paucity of deep-dive data available for retail investors, you can end up down some deep rabbit holes. The best thing to do, says fund managers and advisers active in the ESG space, is to stick with ETFs or investment funds managed by well-known, reliable fund managers, who specialize in the form of ESG that you care about.
“Many companies may look great on the outside, but when you pull back the curtain there may be something rotten underneath,” says James Katz, founder and Chief Executive of Humankind Investments in New York, which focuses on ESG funds. “So there’s really a lot of research that has to be done,” if you are to really understand a company’s ESG performance. Monroe’s group of scientists in Palo Alto have developed a process to fully analyze some 12,000 companies around the world, along with their supply and value chains.
“No company is an island,” says Katz. “Every company is part of a dense network of companies that provide their product or service to people.” At Humankind, Katz and his colleagues have developed a method for assigning responsibility for unwelcome outputs across every piece of the supply chain. That helps them put what they call, of course, the Humankind value of a firm. That’s the kind of research that an individual investor simply can’t do.
Then, there’s the danger of what investors call “Greenwashing,” where investment advisors and fund managers—and even companies themselves—claim magical ESG powers for things they do in the normal run of business. Monroe notes that some large oil companies even get counted as green investments because their toxic emissions are created when the fuel is burned by someone else.
However you ultimately decide to bank your money in sustainable investing, you will need to keep your eyes open. The whole field is emerging and today’s benchmarks may be displaced as social trends and scientific knowledge advance. Who’d have thought an automobile maker would become one of the world’s most valuable companies? Yet Tesla’s promise of an electric vehicle revolution has made a tiny carmaker more valuable than Detroit and Japanese carmakers producing 10 times as many vehicles.
Then there are the ongoing global climate talks. After last year’s COP26 talks in Glasgow, many countries around the world published new standards for curbing carbon emissions through their own legislation and policies, and even if the U.S. has not yet fully signed on to the needed cuts, U.S. companies see which way the wind is blowing, and are cutting their carbon footprints in order to stay competitive.
“As demand increases for ESG investing, several key trends are emerging—from climate change to human rights. The pandemic has turned the spotlight on the interconnectedness of sustainability and financial market performance,” says Jake Walko, Director of ESG Investing and Global Investment Stewardship at Thornburg Investment Management.
So, can you rest easy with your money in an ESG portfolio?
“To be clear,” says Humankind’s Katz, “the jury is out on the question of whether by making socially responsible investments you may get the same return as if you invested in the market as a whole.”
You might expect a socially responsible portfolio could lead to lower returns in the long term compared to another, similar portfolio, that somehow there is a premium to be paid for investing based on your social ideals and values.
But a white paper by the Morgan Stanley Institute for Sustainable Investing, however, shows that this claim is questionable at best, says Betterment’s Bakkum. Analyzing the performance of nearly 11,000 funds from 2004 to 2018 and comparing traditional funds to sustainable funds, the study revealed that there was no trade-off in performance. Though there were small differences in performance over shorter time periods, over the long term there was no meaningful difference.
And the study found that sustainable funds exhibited 20% lower downside risk, as measured by downside deviation.
At Betterment, says Bakkum, “data indicates that the performance of Betterment’s Broad Impact portfolio versus our more standard Core portfolio is not significantly different.” He points to a Betterment case study that shows how the company built three socially responsible investment (SRI) portfolios.
“We’re at the beginning here of connecting the dots of how companies are treating us, the people, outside of simple portfolio returns,” says Katz. “You know it used to be enough for a company to make a decent return, and an investor would say oh this company did well by me. But there’s a bigger picture here that investors have ignored for far too long - how companies treat us as customers, as employees and as members of society, because we’re not just investors, we’re human beings.”
This content was paid for by Betterment. The newsroom was not involved in the creation of this content. Higher bond allocations in your portfolio decreases the percentage attributable to socially responsible ETFs. All investing involves risk, including risk of loss. Performance not guaranteed.