How ESG Investing has Evolved the Socially Responsible Investing Industry
by Trailhead Plan… on Oct 31, 2017
When we discuss socially responsible investment (SRI) with peers and investors we often get one of three responses:
- The 'SRI is risky response': Isn’t investing in solar and green energy high risk (and low reward)?
- The 'All that stuff is great, but it won’t make me money' response: I’m sorry, I’d like to retire someday and when it comes to my portfolio I need to make money.
- The ‘I’m not a tree-hugging hippy response: You’re wasting your time… I don’t really care about being socially conscious with my investments.
Of course, this offers a dilemma. On the one hand, we believe socially responsible investment to be a great starting point for aligning your money with your values. Recent research also points to the fact that socially responsible investing at the very least does not hurt long-term investment performance and may even improve it. We wrote about that here.
On the other hand, socially responsible investment is a vague description, and investors often have no idea what it means or why it is important. As a result, the poor public relations around SRI (seriously, who did SRI hire as its PR firm?) has dampened the enthusiasm for something that is not only good for ensuring your values are represented in your portfolio, but also may be positive for long-term investment returns, corporate health, and economic growth.
So, what’s a diehard socially responsible investor to do?
Enter ESG Investing
Luckily, there’s a new dog in town: ESG investing. And it offers an answer to all the above concerns. As we discussed in a previous blog post ESG stands for Environmental, Social, and Governance. Put simply, investment firms screen companies against these standards to single out the best companies, provide an overall ranking, or to disqualify the bad actors (or all three).
We believe ESG provides a clear definition of what standard socially responsible investment is. This is important, as ’socially responsible’ can mean different things to different people. One person doesn’t want alcohol or guns in their portfolio, another is concerned with environmental sustainability, and a third person is concerned with women’s representation in the C-Suite and equal pay. These are all good things, but there needs to be a set of principles we can all fall back on. This is precisely what ESG offers us.
However, how does ESG investment answer the questions posed by the above individuals? Luckily, that’s exactly where we are headed next.
The ‘SRI is Risky Response’
Prompt: Isn’t investing in solar and green energy high risk (and low reward)?
Reply: You’re right, historically investing solely in solar and green energy has been high risk and low reward. However, screening an index of US large-cap stocks, like the S&P 500, for environmental, social, and governance factors allows us to create a diversified portfolio of stocks that, historically, has performed very similarly to the overall US market. As a result, we aren’t making a concentrated and high-risk bet on green energy, but a diversified allocation to US stocks that have positive sustainability factors.
The ’SRI Won’t Make Me Money’ Response
Prompt: I’m sorry, I’d like to retire someday and when it comes to my portfolio I need to make money.
Reply: I’m happy you brought that up. We are big believers in investing for the long-term - the long-term being measured in decades, not just months or years. in that sense, we think sustainable investing, or ESG investing, is becoming the only investing that matters. As our world experiences greater amounts of social and environmental upheaval, we believe the companies that positively impact our world will thrive while others struggle to adapt. In fact, getting back to the data, multiple studies show that investing according to ESG standards does not hurt long-term investment performance and may even improve portfolio returns.
The 'I’m not a Tree-Hugging Hippy’ Response:
Prompt: You’re wasting your time… I don’t really care about being socially conscious with my investments.
Reply: But maybe you care about investing in well-run, investor-friendly companies. You see, the best companies tend to screen well for Environmental and Social factors, but just as importantly, the screen well on Governance factors. Having top-notch corporate governance means they are transparent with shareholders, they have a high quality board with a diverse array of backgrounds, experience, and qualifications, and that the company is run for the benefit of its various stakeholders, not just to enrich management.
There is a significant amount of research that supports that idea that companies that screen well on governance factors tend to outperform poorly-run and non-transparent companies over the long-run. Notably, it helps avoid many of the duds. For example, Equifax was flagged by a research firm used by many ESG investors as particularly high risk over six months prior to the recent scandal. According to MSCI’s sustainable investment research group (via Barron’s):
Equifax had weak data and privacy security…and exhibited poor citizenship by engaging in misleading marketing, for which it had been fined by the U.S. Consumer Financial Protection Bureau. Its governance, although improving, was also weak. Its CEO, for example, was paid five times the median for executive officers around the country and also held the chairman’s role. Not least, the company’s independent lead director had been around for 25 years.
In this sense, we believe ESG investing, in addition to being socially responsible, is simply investing done right.
Maybe you saw yourself in one of these case studies. Maybe you were already onboard the ESG movement, but needed some help defining it to others. Either way, we hope the above helps spread awareness about the ESG movement. Socially responsible investing, by way of ESG investing, is here to stay, and we think it can be a core component to building long-term and successful investment portfolios.