Q: Several years ago, I heard about something called socially responsible investing. If I recall correctly, socially responsible investing didn’t perform very well. Lately, I’ve started hearing about something called ESG investing. It sounds a lot like socially responsible investing to me. Is ESG just more broker hype or is there something to it?
A: Socially responsible investing, or SRI, is an umbrella term. The general idea is to align portfolio investments with the investor’s core values. There is definitely more to it than broker hype. In fact, SRI is a significant and growing force on the financial landscape.
Socially responsible investing traces its roots back to the Quakers and Methodists of the mid-18th century. John Wesley, the founder of the Methodist movement, was one of the most vocal early proponents of what we now call SRI. He admonished his followers to avoid business practices that could harm others including investing in industries such as tanning and chemical production. Other religiously motivated applications of this philosophy included avoiding investment in companies producing guns, liquor or tobacco.
Over the years, SRI has been invoked to address other social issues ranging from the civil rights battles of the 1960s to the Vietnam war, apartheid, and gender equality in the workplace. More recently, SRI has grown to include a number of other factors. As the scope of SRI has evolved, the name has changed to encompass these concerns. Most people now refer to it as ESG investing, where ESG stands for “environmental, social and governance.” Other names include “sustainable” investing or “impact” investing.
To get a sense of how broadly the ESG umbrella spreads, here are five of the top ESG concerns for 2018 as highlighted in a recent article by Northern Trust’s senior ESG analyst Julia Kochetygova:
1. Climate change.
2. Water scarcity.
3. Sustainable development in emerging economies.
4. Shareholder activism related to corporate sustainability initiatives.
5. Diversity and gender equality.
Investors usually use ESG in one of two ways. Historically, most ESG investors have implemented what is called a negative screen, meaning they exclude companies that violate the investor’s ESG criteria. However, in recent years, some particularly large investors have come to the conclusion that negative screening reduces their influence. Now, instead of avoiding violating companies, these investors identify those where change will have the biggest overall impact and then use their investment muscle to try to drive that change. The California Public Employee Retirement System is the largest player in this area of ESG investing.
Other investors use ESG criteria to find companies that will generate superior performance over time. These investors believe that companies that actively pursue sustainable environmental and corporate governance practices, will also be more successful financially. There is growing evidence these investors may be onto something.
In 2014, Harvard Business School professor George Serafeim looked at the relative performance of stocks for companies that focused on improving their ESG performance. While there are some important nuances to his study, Serafeim found that $1 invested in 1993 in a portfolio of companies with strong ESG efforts would have grown to $28 by 2013. This compares to a portfolio of weak ESG companies which would have only grown to $14.
If you are interested in ESG investing your options are rapidly growing. There are now several ESG-oriented mutual funds and exchange-traded funds. The funds span the universe from equity to fixed income and from actively-managed to passive. Some funds are faith-based and others are purely secular. For those with a contrarian streak, you can even invest in contra-SRI funds, or funds that specifically target the kinds of companies that would never pass an ESG screen.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to: firstname.lastname@example.org