Invest Well and Do Good: A Beginner's Guide to ESG Investing
By some metrics, 2020 has been nothing short of catastrophic.
If you follow the news closely, it might feel like you have woken up in an episode of the popular dystopian Netflix series Black Mirror.
There have been numerous natural disasters in the US, the bush fires in Australia, devastating floods in Indonesia, Cyclone Amphan In India & Bangladesh, and a volcano erupting in the Philippines.
Not to mention the ‘small’ matter of the COVID-19 pandemic.
But with this challenge comes change.
According to a report from Morningstar, investments into Environmental, Social, and Corporate Governance (ESG) assets have gushed in, growing up to 72 per cent this year.
In Q2 2020, the sustainable investment funds saw their assets under management grow to a historic high of US$1 trillion.
This is popular in Singapore too, as according to a report by Standard Chartered Bank, about 4 in 10 of Singapore investors are thinking about allocating 5 to 15 per cent of their funds to sustainable investments over the next three years.
But, what is ESG Investing you may ask? Can you invest and do good at the same time?
What are the upsides and risks of this investment strategy?
Here is all you need to know!
What is Environmental, Social, and Corporate Governance (ESG) Investing?
“ESG Investing is the consideration of environmental, social and governance factors alongside financial factors in the investment decision–making process.
~Remy Briand, Managing Director of Morgan Stanley Capital International (MCSI) ESG Research
In less dry terms, ESG investors analyze how management and the board treats all its stakeholders, as well as looking at whether the business is run ethically, and whether the there is alignment with corporate incentives and the business’s success.
Corporate Governance topics to research and analyze include:
- Executive compensation – Are employees well paid?
- Board accountability and the independence of the board – Does the board act independently?
- Transparency and disclosure – Is the company forthcoming with information?
- Management structure and diversity – Does the company conduct fair employment practices?
- Conflicts of interests and Corruption – Does the company have a strong system to prevent his from happening?
- Shareholder rights – What rights. do the shareholders have?
Upside to Sustainable Investing
On top of taking a stand and doing good with your investing, there is a growing financial upside of the ESG Investing strategy too.
There have been a couple of studies that demonstrate that ESG Investments perform comparatively better than their non-ESG competitors; with academic literature suggesting that companies with good ESG performance are exposed to less market volatility, carry lower risk, and achieve better financial performance
First, we have a 2015 study by global asset management firm Arabesque and the University of Oxford entitled From the Stockholder to the Stakeholder.
The study, which surveyed about 200 scientific sources on the economic effects of sustainability found that companies with good ESG performance tend to have:
- Better stock price performance (80% of the studies).
- Better operational performance (88% of the studies).
- Lower cost of capital (90% of the studies).
Another 2015 meta-study by the Morgan Stanley Institute for Sustainable Investing supports the above thesis.
The Morgan Stanley researches evaluated seven years of performance data for 10,228 open-end U.S. mutual funds and found that the sustainable funds generally had slightly better returns and were less volatile than their traditional counterparts.
More recently, popular sustainable funds in the US like the:
- Vanguard FTSE Social Index Fund (fund that does not invest in ‘unethical’ companies like tobacco, pornography and marijuana companies);
- Parnassus Endeavor Fund (fund focuses on companies with that rank well on employee treatment and excludes some sectors);
- BGF Sustainable Energy Fund (fund mainly consists of renewable and sustainable energy companies);
have been performing well.
Granted, as always, I would like to remind you that past performance is not indicative of future performance.
But, over the long term, the evidence that ESG outperforms over longer periods is still not conclusive.
Risks of Sustainable Investing
However, it is not all bright shiny electrical vehicles, green power and a brighter future for ESG companies.
This ESG Investing strategy has a few drawbacks.
First and foremost, researching ESG compliant companies can get complicated, as a transparent, consistent and standardised means of comparison is still not there yet.
You will also have to dig deep and look beyond annual reports and sustainability reports to suss out whether a company is really a company that takes ESG.
Thankfully, there is a growing number of NGOs and financial institutions that are helping to provide more information.
Secondly, in the future, there might be a point in time where social good and financial interests align. After all, there won’t be any investment profits to talk about if our earth is ruined by climate change.
But that could be years or decades before that happens.
Investors with a more realistic time horizon of about 20 years might not be able to wait that long.
Also, there is not a strong correlation between companies with strong ESG performance and the success of the companies.
For example, let’s take a look at the Vanguard ESG U.S. Stock ETF (ESGV) which has gone up in price by about 20.1 per cent since its inception in 2018.
The ETF’s top seven holdings consist of Apple, Microsoft, Amazon, Facebook, Google and Tesla, that account for about 25 per cent of the fund’s value.
If the tech stocks do badly like during the recent September US stock market sell-off and the sustainable Vanguard ESG U.S. Stock ETF crashed; it does not mean that ESG as an investing strategy is has failed.
Neither does it mean that good ESG performance is good for growth.
Ultimately, you will need to manage your expectations when engaging in ESG Investing.
You have to be prepared to deal with lower returns from your investments in exchange for positive overall outcomes in society and the world
Although investing in ESG assets can be risky, it can have a big positive impact on society.
Some Funds or ETFs to Consider
If this strategy appeals to you, and you don’t want to do stock picking, here are some of the more popular funds and ETFs for you to research on:
- Allianz Global Sustainability Fund
- First Trust ISE Global Wind Energy Index Fund (FAN)
- Invesco Cleantech ETF (PZD)
- iShares MSCI KLD 400 Social ETF (DSI)
- iShares MSCI Global Impact ETF (SDG)
- Vanguard ESG U.S. Stock ETF (ESGV)
Disclaimer: The information provided by Seedly serves as an educational piece and is not intended to be personalised investment advice. Readers should always do their own due diligence and consider their financial goals before investing in any stock.
Got Questions About Investing?
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