Matt Stead
Risk and ROI are always going to drive investment decisions. But more and more, people are considering the social and environmental impact of their investment dollars. Environmental, social and governance investing is something that many clients are starting to talk to their financial planners about. If you’re thinking about adjusting your portfolio with a focus on ESG* investing in 2022, here’s what you need to know.
What is ESG Investing?
ESG investing essentially means considering environmental, social and/or governance criteria when evaluating companies to invest in, and favoring companies that rate well with these criteria.
- Environmental factors include things like whether a company contributes to greenhouse gasses and generates other forms of pollution; how it uses/conserves energy; its efforts around climate change; and how it uses land, water and other natural resources.
- Social factors include things like a company’s labor and safety standards, its efforts around diversity and inclusion, and its community impact/reputation.
- Governance factors include things like transparency around taxes and reporting, the structure of a company’s board of directors and its core values—essentially, its integrity.
Assessing a complex mix of ESG factors is obviously challenging, so individuals look at companies’ ESG scores when making decisions around ESG investing. Third-party organizations calculate these ratings to give investors a sense of how a company’s ESG performance and risks compare to those of its competitors. Investors can directly invest in companies whose ESG practices they endorse, or invest in funds comprised of companies with high ESG scores.
Investing in companies with socially responsible practices is an attractive investment strategy for a few reasons. One, many people feel strongly about aligning their investment dollars with their own values. Two, assessing a company’s ESG performance is one useful indicator of its risk as an investment. A company that’s actively polluting or has a history of ignoring sexual harassment claims might be headed for major legal action or total collapse in the near future. Identifying ESG risks helps investors steer clear of companies that could be bound for trouble.
ESG Investing vs. Socially Responsible Investing
People often and understandably confuse ESG investing with socially responsible investing. They’re very similar concepts. While both ESG and SRI are strategies employed by people who are concerned about the societal impact of their investments, the two terms describe slightly different approaches.
ESG investing balances social values with financial performance. Investing in ESG funds means making profit-driven decisions that also consider environmental, social and governance criteria. Socially responsible investing puts more emphasis on the investor’s values. Someone who commits to SRI might screen out any companies that don’t use green energy, for example, even if that decision means lower returns on their investments.
ESG Investing in 2022
The popularity of ESG investing has been steadily growing, and industry analysts expect that trend to continue. More than $650 billion was invested in ESG-focused funds worldwide in 2021, up from $542 billion in 2020 and $285 billion in 2019. About 10 percent of fund assets worldwide were held in ESG funds, as of late 2021.
It’s not surprising that ESG investing continues to gain popularity, considering the strong performance of many ESG funds in recent years. S&P Global analyzed 26 ESG funds over the first year of the pandemic and found that 19 of them outperformed the S&P 500. It’s evidence that practicing socially responsible investing doesn’t necessarily mean sacrificing financial gain.
What does the next few years look like for ESG investors? MSCI ESG Research identified 10 ESG trends for 2022. Some of them affect companies more than individuals. (For example, MSCI predicts that corporations are going to feel increased pressure to reduce their greenhouse gas emissions by developing net-zero supply chains.)
For investors, MSCI’s research suggests that 2022 trends will include divesting from coal, investing in green bonds to expand climate adaptation and investing in biodiversity. MSCI also anticipates that, as ESG investing becomes increasingly more mainstream, regulation and rating systems will become more standardized—in other words, it should get easier to compare comprehensive ESG criteria when you’re making investment decisions.
What You Need to Know About ESG Investing
Don’t be overwhelmed by wading into the world of ESG ratings and trends. If you’re interested in making investments in a way that’s guided by environmental, social and governance factors, start by having a conversation with your financial planner. There’s a broad range of ways to incorporate ESG investing into your long-term investment plan. Your financial planner will want to know about your specific goals before helping you shape an investment strategy.
Sachetta, LLC’s advisors are here to help you navigate any questions that come up for you around investing. If you’re interested in ESG investing, or have other questions about better aligning your investments with social and environmental values, contact us today.
Matthew Stead, MSFP, joined our team in 2014. He obtained a bachelor’s degree in finance at Bentley University and his master’s degree in financial planning (MSFP) at The University of Georgia. He is sitting for the CFP® shortly. Matt wears a variety of hats in the office but primarily serves as the director of operations for our wealth management team, as well as building and maintaining our IT infrastructure. He also is the host of our podcast Fine Answers.
* There are potential limitations associated with allocating a portion of an investment portfolio in ESG securities (i.e., securities that have a mandate to avoid, when possible, investments in such products as alcohol, tobacco, firearms, oil drilling, gambling, etc.). The number of these securities may be limited when compared to those that do not maintain such a mandate. ESG securities could underperform broad market indices. Investors must accept these limitations, including potential for underperformance. Correspondingly, the number of ESG mutual funds and Exchange Traded Funds (“ETFs”) are few when compared to those that do not maintain such a mandate. As with any type of investment (including any investment and/or investment strategies recommended and/or undertaken by Adviser), there can be no assurance that investment in ESG securities or funds will be profitable, or prove successful.