Environmental, social, and governance (ESG) investing has grown enormously in recent years. With more people considering the impact of their money, many wonder if ESG funds can deliver returns comparable to conventional options. The answer largely depends on your strategy.
What Exactly is ESG Investing?
ESG investing incorporates non-financial factors into investment decisions, focusing on companies making positive impacts related to:
Environment – Issues like climate change, carbon emissions, pollution, recycling
Social – Factors such as employee relations, diversity, health and safety
Governance – Executive pay, corruption, transparency, board independence
By directing money toward more sustainable and responsible companies, ESG investors aim to encourage better long-term practices while still earning solid returns.
Why Has Interest Grown So Much?
Several driving forces explain the surge in ESG fund investing:
Increased Options – More ESG mutual funds and ETFs exist now, providing exposure to “green” companies across sectors and asset classes. This expands choices beyond restricting investments only to certain industries.
Mainstream Adoption – Major financial institutions like BlackRock and Vanguard now offer ESG fund options. Standardized ESG reporting metrics help investors evaluate opportunities. This boosted mainstream credibility.
Corporate Commitments – Shareholder demands induced more corporations to set environmental and social goals. And research revealed operational efficiencies from implementing more ethical governance policies company-wide. Doing good became good business.
With this “perfect storm”, ESG investing evolved from a niche corner of the market to one of the biggest investment trends.
Do ESG Funds Sacrifice Returns for Morals?
Critics argue avoiding major industries like fossil fuels inherently limits your profit potential. And screening out stocks based on non-financial factors seems counter to the goal of maximizing investment returns.
However, the trade-off between profit and morals has become a myth in modern ESG investing:
- Diversified Funds – Many ESG funds provide wide exposure across business sectors, not just expensive niche industries. This diversity aims for market-like returns.
- Positive Screens – Funds often screen for companies with good ESG metrics relative to peers, not based on absolute thresholds. This captures firms likely to outperform industry averages.
- Risk Mitigation – A company managing ESG risks well signals strong leadership and strategic governance overall. This can indicate resiliency and financial strength.
- Future Focus – Even without immediate payoffs, ESG factors like renewable energy investments may position a company to capitalize on long-term trends.
In essence, incorporating environmental and social responsibility into business decisions generally aligns with serving all stakeholders successfully over extended periods. And smart governance just makes fiscal sense.
While some actively managed ESG funds carry higher expense ratios, they may justify the fees through expertise in identifying sustainable firms poised to profit. Or you can choose efficient index funds tracking benchmark ESG indices. Either way, you need not sacrifice returns to reflect your values.
And if you still carry debt like credit cards or quick and easy loans online, focusing any investing first on wiping out high-interest balances makes smart financial sense too.
Are Specific ESG Funds Less Risky Than the Overall Market?
Some research suggests that ESG funds may carry lower risk compared to the overall market, particularly during downturns. By excluding ethically questionable stocks, ESG investors avoid industry volatility. For instance, fossil fuel and tobacco companies often face dips due to legal issues or scandals. Governance failures like corporate fraud trigger significant stock declines. ESG funds mitigate such risks by screening out unethical companies and emphasizing long-term governance.
However, they still face macroeconomic forces, limiting their ability to eliminate market risk. Ultimately, while ESG funds may mitigate certain risks, they remain subject to broader market forces like conventional funds.
What Steps Should New ESG Investors Take?
For those excited to align investments with their values, a few tips applying general sound investment practices to ESG funds can set you up for success:
Determine Your Risk Tolerance – ESG investing options span the risk spectrum from money market funds to emerging market stock funds. Choose based on your growth goals and ability to weather volatility. Conservative choices exist if you prioritize capital preservation.
Consider Index Funds – For hands-off investors, index funds like ESGV track benchmark ESG indices offering diversified exposure while minimizing expenses.
Hold For the Long-Term – Given their future-focused screening criteria, ESG fund holdings may take time to realize full profit potential. Patience allows strategic advantages to materialize.
The key is letting your investment objectives and risk tolerance guide how you incorporate ESG funds into your portfolio, not getting distracted by their packaging alone.
Can I Make Money While Positively Impacting the World?
Skepticism endures around whether ESG investing truly influences corporate ethics or simply constitutes “greenwashing” – companies promoting unsubstantiated environmental claims for marketing purposes alone.
In truth, ESG investing today fuels positive change OR profitable returns more than achieving both simultaneously:
- Divesting from oil companies based on environmental factors can hurt returns but has reputation effects.
- Screening for companies with good management relative to peers boosts returns but has unclear social impacts.
However, money-building sustainable future infrastructure or governance models incrementally move markets towards more responsible capitalism. So ESG investing can further positive change indirectly by allocating capital to more conscious companies rather than avoiding “sin stocks” altogether.
The real power lies in widespread adoption. If enough investors collectively shift assets to reward firms implementing ethical practices, more corporations evolve to meet shareholder demands. This means companies wanting to attract investment capital must up their ESG game. So while systemic change takes time, dollars do talk.
The savviest investors select ESG funds using sound investing fundamentals more than lofty ethical goals alone. But in the process, they incentivize incremental improvements benefitting society and the environment as a byproduct of seeking returns.
So while “having your cake and eating it too” may overstate the direct impacts today, allocating investment money toward ethical companies does ultimately help move markets in a more sustainable direction. If approached responsibly, investors can generate solid long-run returns AND gradually improve corporate impacts – even if those goals conflict sometimes in the short term.
