What Is ESG Investing?
ESG investing allows you to invest in companies that align with your values. Learn how it works and why it’s important here.
It’s always important to invest your hard-earned money in companies you feel good about. Aside from healthy returns, some turn toward environmental, social, and governance (ESG) investing to find high-quality securities. The term refers to companies that are socially responsible or sustainable.
In this article, we’ll explain how ESG investing works and why it’s important. You’ll also learn who might gravitate toward this approach, as well as its pros and cons. Finally, we’ll break down how you can begin buying these types of securities, either through your current account or a new one.
Understanding ESG Investing
Environmental, social, and governance (ESG) investing (or socially responsible investing) is an approach that emphasizes both sustainable and socially responsible securities. Experts and investors alike use the term in reference to a given company or investment. Here’s a more detailed look at what each term means:
- Environmental. This refers to securities that espouse improving or conserving the world. More specifically, this applies to those that are associated with clean energy, preventing climate change and deforestation, as well as biodiversity.
- Social. This term applies to companies and securities that seek to foster better relationships and improve people’s lives. Common examples of this include those related to customer satisfaction, security, human rights, gender, and labor.
- Governance. This refers to a security that focuses heavily on managing company standards. For instance, those that emphasize issues such as corporate governance, whistleblower schemes, corruption, and executive compensation apply here.
With ESG investing, you’re essentially prioritizing putting your money toward securities that improve the world or that align with your values. These can come in the form of stocks in public companies or mutual funds that fit the general criteria, which we’ll expand upon later.
Lately, brokerage firms are making it easier to invest in ESG securities. For example, advisor firms, such as Betterment and Vanguard, provide model portfolios that include investments that fit this mold.
Why ESG Is Important
Traditionally, the goal of business and investing is to turn a profit. If a company or security historically does well, people may be more inclined to put up their hard-earned cash. However, today, financial success isn’t the only reason why some invest their funds. Now, many also prioritize filling their portfolio with securities that align with their values. For this reason, ESG investing is rising in prominence and importance.
Taylor Kovar, CFP and CEO of Kovar Wealth Management, breaks down the importance of ESG investing, saying “By focusing on companies that prioritize environmental sustainability, social responsibility, and ethical governance, investors can contribute to positive change while potentially reducing exposure to companies with higher regulatory and reputational risks.” Essentially, by buying into firms that make a positive impact, one can make a difference and avoid those with negative actions and behavior.
As mentioned, a big reason why ESG is important is because investors want to keep unethical or negatively reputed companies out of their portfolios. Nick Cantrell, founder and Wealth Advisor at Green Future Wealth Management, expands upon this, explaining that investors may “want to avoid want to avoid companies that are involved in fossil fuels or weapons,” while also increasing “their exposure to companies with strong LGBTQ policies.” He also adds that this approach is crucial because “it can deliver about 20% lower downside in troubled markets, so incorporating ESG investing can help you lose less money the next time the market turns south.”
Overall, investing in ESG companies can help people feel like they’re making the world a better place. It can also help people avoid the issues that go along with firms with a negative reputation or that are involved in unethical business.
How the ESG Criteria Works
There is no definitive rule for what constitutes an ESG investment, but many use general criteria to identify them. These commonly include the characteristics we outlined above. Additionally, some research firms rate securities based on a scoring system unique to them.
Andrew Bellak, a partner and wealth advisor at Perigon Wealth, defines the ESG criteria as a “spectrum” rather than a “simple binary worthy” or “not worthy.” He adds, “All public and private companies and issuers of securities including governments can be judged both in isolation and against their peers to make either absolute or relative conclusions.” Bellak explains that we have organizations like the “Sustainability Accounting Standards Board – SASB to complement the Financial Accounting Standards Board – FASB as one well-known framework” to judge these types of securities.
While ESG research firms and organizations like the SASB and FASB can help define the sector, Cantrell cautions that “there is no silver bullet,” or overarching “metric that should govern your investing decisions.” From his point of view, “ratings firms like MSCI and Sustainalytics” can’t quite “capture the essence of the sustainable investing purpose that many” are looking for. So, keep in mind that, while ratings firms can be helpful, they aren’t necessarily the end-all, be-all guideline for this investing approach.
Pros and Cons of ESG Investing
ESG investing can be beneficial for many because they can feel like they’re making a difference. It also helps them keep companies that either don’t align with their values or ones with a negative reputation out of their portfolio. However, it can also be limiting, especially if you only choose to invest this way.
Below are the pros and cons of buying ESG securities:
- Allows you to invest in companies that align with your values
- Focuses on companies that aim to leave a positive impact on the world
- Less exposure to companies that conduct unethical or questionable business
- No definitive rules for what constitutes an ESG investment
- Sticking to ESG can limit you from investing in other companies that don’t align with this approach
- Companies could use “greenwashing,” in which they overstate or mislead investors on their ESG characteristics
Who Should Choose ESG Investing
ESG investing is a trendy approach today, but it may suit some more than others. For instance, if you’re intent on only putting money into companies that put the world first, you may want to look toward this strategy. On the other hand, you may be more inclined to invest traditionally if you’re more profit-focused or have no preference when it comes to firms aligning with your values.
According to Kovar, this approach is “ideal for investors who want their investments to reflect their ethical and environmental values.” Additionally, he says it’s also “suitable for those who believe that ESG factors can lead to long-term profitability. However, investors looking for quick returns or those who prefer traditional investment analysis methods without ESG considerations might steer clear of it.”
Some might also choose to avoid ESG investing for “political or ideological reasons,” says Bellak. In recent years, the approach has come under fire from conservatives, such as politicians, for being “woke.” This is, in large part, due to it focusing on companies that prioritize key issues like climate change, gender equality, and executive compensation, which are hot topics in the political sphere.
Ultimately, whether or not you buy ESG securities depends on your core values as an investor and person. If your main goal is to support companies that match your ideological objectives, it could be a good fit. However, as mentioned above, you may steer clear of this strategy if you don’t want to be limited and want to invest more traditionally.
How to Invest in ESG Securities
You can invest in ESG securities through most brokerage firms, including through an investment management company. Additionally, some robo-advisor firms, such as Betterment, Wealthfront, and Vanguard, offer model portfolios that cater to this approach. However, it’s important to do your research before you invest your funds.
To learn more about these types of securities, Bellak recommends retail investors “check out As You Sow and Morningstar’s Sustainability rating powered by Sustainalytics.” He also adds, “Many of the authentic ESG fund companies have good info on their websites like Calvert, Impax, Parnassus, Green Century, Trillium, Domini, Change Finance, Adasina, Nia Global Impact, and Boston Common Asset Management to name several.”
It’s also a good idea to speak with a financial advisor before you begin any investing approach. We recommend you look for a fiduciary advisor, whether you work with them in a discretionary or non-discretionary capacity. They can help you go to the drawing board and figure out how to add ESG to your portfolio. You can use a free matching tool, such as this one, to find a vetted professional near you.
Frequently Asked Questions
Is ESG investing good?
This depends on your values as a person and investor; however, several benefits can come from ESG investing, such as lower volatility and aligning yourself with companies that you agree with. We recommend consulting with a financial advisor before deciding whether this approach is right for you.
What is an example of ESG investing?
Per Kovar, a good example of this is a “mutual fund or ETF that invests in companies leading in renewable energy, and sustainable agriculture or firms with strong corporate governance and diversity policies.” He also explains that “these investments not only support progressive practices but tap into emerging market trends.”
Why is ESG investing controversial?
In recent years, some have criticized the ESG approach because they classify it as being “woke.” This is mainly because it focuses on progressive policies, products, and initiatives that clash with their views. The strategy is also susceptible to “greenwashing,” in which companies misrepresent or overstate themselves as ESG to entice investors.
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