The concept of brand loyalty has changed over the last 20 years. In the early 2000’s, many Americans felt connected to a brand or company based on their aesthetic, television commercials, spokespeople, or product line. But over the last two decades, American consumers have navigated away from service-level loyalty and instead dug deeper into the companies behind the product. Informed consumers are gravitating towards companies with higher ethical standards, who are more socially conscious and have begun to shy away from those with controversial or corrupt practices. This is why over the last two decades the concept of ESG investing has become more prominent.
In the quest for a sustainable future, investors are turning to Environmental, Social, and Governance (ESG) investing. With a focus on factors like climate change, social responsibility, and corporate governance, it’s no wonder why this investment strategy has gained in popularity. Below we provide a comprehensive look into ESG investing and its potential for a sustainable future.
What is ESG Investing?
ESG investing is an investment approach that takes into account the environmental, social, and governance factors of a company or organization. It goes beyond traditional financial analysis by considering the potential risk and opportunities associated with a particular company or organization and their environmental responsibility, social consciousness, and governance practices.
Environmental (E)
This aspect focuses on the company’s impact on the environment. Factors considered may include climate change, resource use, waste management, and environmental regulations compliance.
Social (S)
The social component evaluates a company’s relationships with its employees, communities, and the broader society. Social factors may include labor practices, employee relations, diversity and inclusion, community engagement, and product safety standards.
Governance (G)
Governance refers to the structure and practices of a company’s leadership and management. It involves assessing the effectiveness of the board of directors, executive compensation, shareholder rights, company transparency, and ethical business practices.
ESG investing aims to align investment decisions with values that go beyond financial compensation.
The Roots of ESG Investing
While ethical investing seems like a trendy approach, the concept of socially responsible investing (SRI) dates back to the 1960s when individuals and institutions began to express concerns about the ethical and social implications of their investments.
The SRI movement gained traction with social and political issues at their height. Investors began to recognize the impact that corporate activities could have on broader societal issues. These concerns laid the foundation for ESG investing for investors who sought to align their investment choices with their ethical and social values.
The concept evolved over time, and the term “ESG” became more prominent in the 2000s, reflecting a more structured framework that includes Environmental, Social, and Governance factors. The ESG framework provided a more standardized approach to evaluating companies based on sustainability criteria.
Today, ESG investing has become a mainstream consideration for a wide range of investors. It’s become so big in fact that investors who use one more more ESG criteria controlled $8.4 trillion in U.S.-domiciled assets in 2022, according to US News.
Getting Started with ESG Investing
If you’re interested in incorporating ESG into your investment strategy, here are a few steps to get started.
Understanding ESG Criteria and Frameworks
A crucial aspect of ESG investing is understanding the criteria used to evaluate companies. Various frameworks, such as the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB), provide guidelines for assessing ESG performance.
Identify ESG Investment Opportunities
Start by researching ESG-focused mutual funds, exchange-traded funds (ETFs), and index funds. These investment vehicles pool together a diverse range of ESG-compliant companies, allowing investors to gain exposure to multiple sectors while aligning with their values.
It’s important though to do further research into the fund itself, and review how long the fund has had its ESG mandate. In some cases, fund companies may add the term “sustainable” to a fund’s name in order to attract new assets. So although the fund may have a mandate for sustainability, the impetus for the name change might have been marketing related. To combat this the SEC has started stepping up its oversight of ESG funds and have instituted rules to avoid misleading fund names.
Another option is to pick your own stocks. You may also want to consider using ESG screens on websites like Morningstar, which will filter out companies or industries, such as tobacco or weapons, that do not align with your values.
Be aware that building a portfolio of ESG stocks can be time consuming as you’d need to monitor each individual company. Additionally performance of the portfolio may vary compared to the overall market due to high levels of sector or industry concentration.
Evaluating ESG Performance
When evaluating companies for ESG performance, consider a holistic approach. Look into the company’s environmental impact, such as carbon emissions and resource usage. Assess their social impact by examining diversity and inclusion practices, labor conditions, and community engagement. When evaluating their governance structure, focus on board diversity, executive compensation, and shareholder rights.
Many financial platforms and research providers offer ESG scores and data to help you make informed decisions.
Understanding Potential Risks for Trusts
For trustees and fiduciaries, integrating ESG into a trust’s portfolio can actually increase liability unless the trust specifically mentions ESG investing. This is because a fiduciary must administer the trust according to the trust document. Unless the trust specifically calls for ESG investing, the trustee must instead follow the specific requirements of the Uniform Prudent Investor Act, which requires that a trustee exercise care, skill and caution as a prudent investor would. Trustees are held to specific standards such as diversification, tax consequences, total return, liquidity etc, that an individual is not normally held to. A trustee might run into a conflict when a trusts’ remainder beneficiaries would like to invest in ESG investments even when the trust does not specifically spell out such a preference. In this case the trustee should consult an estate planning attorney and also consider getting a waiver of liability signed by the beneficiaries.
Lean on an Experienced Advisor
An experienced investment advisor can also help you identify ESG investment opportunities and ensure you’re keeping a diverse portfolio. They can provide guidance based on your personal financial situation and ESG investing goals.
Remember, while ESG investing may align with your own ethical standards it should also align with your overall financial strategy and goals.
Stay Informed
ESG considerations and ratings can change over time. Select companies may fall in and out of the index, like Tesla did in 2023. That’s why it’s important to continuously monitor and evaluate your investments to ensure they remain aligned with your ethical and financial motives.
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Creating a Sustainable Future
ESG investing offers investors an opportunity to align their investment portfolios with their values. By investing in companies with positive social and environmental practices, investors can contribute to a more sustainable future.
ESG investing is a dynamic field and there are a range of approaches. If you feel compelled to invest in socially responsible companies, consider consulting with a member of the Prudent Investors team to learn more.
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