How to engage and navigate the new sustainable investment frontier: ESG investing

Key Takeaways

• Investing sustainably is growing in popularity as investors are looking to align their investments with their beliefs and ideals. 
• There is a minefield of definitions for ESG investing, so it’s critical you decide what you are looking for in your investments. 
• Read the fine print of whatever fund you want to invest in to ensure their ESG definition matches yours. 

Financial Disclosure 

This is an educational blog to inform individuals on ESG and the role it plays in the investment sector. Sustainable Earth and the writers are not financial advisors and are not offering financial advice. Consult with your financial advisor before making any decisions to invest. 

From Spark to Flame 

In 2020, the CEO of Blackrock, the largest asset manager globally, published its annual letter to CEOs. In this letter, he asserted the materiality of climate change and how companies must prioritize their sustainability to survive in the long term. Blackrock manages around $10 trillion worth of assets. And that’s why it’s such a big deal that Larry Fink said this. Due to Blacrock’s influence on the global economy, this push for sustainability resonated worldwide.

What is ESG Investing and why care?

To better understand the world of ESG investing, we spoke with Dr. Christoph Schiller, Assistant Professor of Finance at the W.P. Carey School of Business at Arizona State University. Dr. Schiller says that there is great diversity in the people using the term “ESG investing,” and therefore, it can mean different things depending on who you ask. However, generally speaking, ESG investing considers environmental, social, and governance concerns above and beyond other financial considerations when making investment decisions. This can look very different depending on who you ask, so it’s important you define what concerns are important to you before starting.  Things investors might be interested in include greenhouse gas emissions, energy use, pollution, diversity, gender inclusivity, or living wages. 

As a recent approach to investment, Dr. Schiller says there are two schools of thought for why people engage in ESG investing: 1) Investors are looking to align their money with their beliefs and attitudes to support sustainability. This includes divesting from “bad” companies and investing in “good” ones. 2) Some investors believe that companies incorporating sustainability into their business practices are less risky as a whole, and are therefore a good investment. Some of the risks investors care about include Supply Chain and Climate risk.

Traditionally, companies have had to disclose their financial performance via financial statements. These have been standardized for decades and are required of companies trading in the stock market. Beyond financial disclosures, investors are now pushing for companies to disclose how companies affect the environment and how people are being treated. In response to the growing demand, companies all across the world have started to release sustainability reports, detailing these risks and how the company is approaching them. However, as ESG reporting is still very new and not legally required, there is no standard framework or universally-accepted regulator of these reports. Due to this lack of regulation, there is a lack of uniformity across companies as well as the possibility of greenwashing.

In response to the growing relevance and materiality of ESG reporting, the SEC has put forward a proposal that would require companies to disclose climate risks along with their financial reporting. Although still in the commenting stage, many expect this new regulation to make waves in boosting the ESG market. 

Is Sustainable Investment smart/safe?

As Dr. Schiller brought up, you might not be able to have your cake and eat it as well. Often enough, companies fairing better in the ESG realm are more stable, meaning that the return on investment might not be as high compared to non-ESG companies. Dr. Schiller points out that in some cases, investors might sacrifice 1-2% of their investment by instead receiving that promise that their investment is supporting ESG projects. 
However, just because you’re supporting companies engaged in sustainability, does not mean you have to sacrifice profitability. The Harvard Business Review found that “14 of 17 ESG-focused exchange-traded funds (ETFs) outperformed the S&P 500 from January to May.”

Companies engaged in sustainability practices are more likely to think long-term and holistically about their well-being, so it follows that they are also more likely to thrive in the stock market, especially during rocky times. This follows the second school of thought Dr. Schiller mentioned, which finds that companies engaging in ESG behaviors are less risky. 

How does one invest in sustainability?

Because of the high variability and diversity in the definitions of what ESG investing is, you have to define what exactly it is you are looking for. Are you interested in greenhouse gasses and pollution or focusing more on gender equity and racial diversity? Because different definitions for ESG might include or excluded different measurements and thresholds, you should come with an idea of what you’re looking for. 

There are many strategies depending on your approach to sustainability. Many companies publish ESG (Environmental, Social, and Governmental) reports detailing their sustainability metrics and goals. This is a good place to start to better understand what a company is doing in their operations to be better. The tough part about these reports is that they’re often long and hard for the average reader to understand. 

In response to this challenge, rating companies have started rating publicly traded enterprises on their ESG developments. Bloomberg, MSCI, and S&P 500 are all financial companies that have created indices tracking and measuring ESG stocks. Instead of investing in just a few companies, you can invest in an index fund or exchange traded fund (ETF). If you want to learn more about what those are, check out this engaging  explainer. Each fund has a different approach to determining the criteria for their chosen investments. Some are strictly no fossil fuels, some look at progress made in ESG performance, and others may focus more heavily on some environmental, social, or governance aspects of companies. This is why it’s so important to have an idea of what ESG means for you, so you can search for the funds or companies that better align with your goals. 

Resources For You

We understand that introducing a whole new world of considerations to your investment strategy can be overwhelming. Here is a resource that can help guide your journey into the ESG world:

• The Principles of Responsible Investment: A UN-backed network of investors, aiming to make ESG investing more straightforward. They provide tools, news, and other resources to help you navigate ESG investing. 

At the end of the day, it is best to do your research into which companies that you are investing in, why you are investing in them, and what your goals are with your investments. Make sure to look at the fine print whenever you invest in an ESG fund, since definitions can vary from fund to fund.

 As an investor, you hold direct power over which companies you support with your finances. Making choices to invest in more sustainable companies is the better choice for you and your dollars in the long-run, but it is not alway an easy task. Make sure to speak with your financial advisor before making decisions regarding finances.