6 Essential Questions To Ask About ESG Investing
With the effects of climate change on the rise and the commensurate effort beginning to address it, as evinced by the adoption of the UN SDGs, both businesses and investors are changing how they operate and where to invest. For businesses, it is through ESG-friendly policies. For investors, it’s investing in ESG-related products.
While the idea of supporting companies that align with your personal values may be good, investors should be asking essential questions around the reality of business performance before taking it seriously. With many companies still learning the ropes of ESG policy-making or blatantly greenwashing, it helps to ask the following questions.
1. What Is And Isn’t ESG Investing?
Whether you’re a veteran or novice investor, it’s important to understand exactly what ESG is and isn’t. At the core of it, ESG will focus on environmental, social and governance criteria. Companies are each given an ESG score based on those criteria so investors can compare how well companies actually perform. What increases or decreases that score varies widely.
For environmental criteria it could include:
Policies on climate change
Recycling and waste disposal practices
Water use and conservation policy
And carbon emissions both in making the product and its everyday use.
For social criteria it could include:
What labour policies they have
How diverse their employees are
Customer service performance
Policies on sexual harassment
For governance criteria it could include:
How diverse management is
Policies pertaining to ethical business practices
Executive pay range
Company lobbying practices and potential corruption
2. What Criteria Should I Pay The Most Attention To?
Out of the three, the most important is the one that you value the most as an investor. The nuances of any ESG rating system reflect this, so its significance is based on investors' own values and what is logical for the company.
For example, some investors are institutionally averse to certain product categories, like tobacco, alcohol, or firearms. Others would simply opt for the company with the leading ESG rating in a particular sector. Some might not care about the score or what they produce and would instead look at the company’s specific policies on climate change.
The most important criterion comes down to what you value the most and what kind of change you want to see in the world. Being genuine in this regard demonstrates an authentic attachment to ESG, your commitment to adopting change that will address climate change in a specific way.
3. Are Companies Transparent About ESG Practices?
Even though many companies understand ESG values and practices are crucial, there is only so much a company can show. Beyond that, investors will have to take the company’s word at face value and be unable to investigate and verify on their own.
This is where regulatory boards come in where they set standards and guidelines so investors can have expectations for what a company will do. This is in addition to being able to evaluate whether their ESG practices will help a company achieve their stated goals in reports.
4. Is Being A DIY ESG Investor A Good Idea?
For those who are already trading and want to do their own research on ESG policies or on particular companies and funds, a DIY approach could be realistic, though it might be ideal to work with a financial advisor or robo-advisor initially. These individuals will manage a portfolio for you.
Regardless, there is no superior method as each one is appealing in various circumstances.
5. Which Is The Best Asset To Invest In?
Between stocks, mutual funds or Exchange Traded Funds (ETFs), the best one will largely depend on the individual’s control over the process, the returns you’re looking for, and your tolerance for risk. While stocks provide dividends and accelerated growth opportunities, these always require adequate research in advance. Furthermore, stocks carry more risks than funds and there may be trading fees involved too.
ESG ETFs avoid the research process entirely and offer a pool of ESG companies to choose from, although it should be noted that ETFs can still charge management fees.
ESG mutual funds are the most hands-off approach as they are managed by someone else. Financial advisors will often recommend these. The important thing to be aware of is the management fees and also account minimums.
6. Does ESG Investing Affect Portfolio Performance?
Investment performance is never guaranteed, of course, and it’s hard to say whether investing in non-ESG companies may sometimes be a better bet than ESG investing. However, with the conversation shifting towards ESG and its longer-term investment viability, the overall idea of ESG investing is becoming more appealing.
That said, in terms of actual performance, a Royal Bank of Canada article citing multiple reports found that ESG initiatives do improve a company’s profitability. This in turn can result in higher dividends than companies without ESG policies.
In short, ESG encompassess a range of values that can be applied across the spectrum of business activity. Companies that choose to solidly explore and align themselves with their chosen values are opting to acknowledge the reality of a changing world that urgently needs us to adapt. Investing in ESG is a byword for investing in the future. Whether you feel that is an important enough reason, in of itself, for you to invest in ESG, is perhaps the only question you need to ask.
Consider for yourself how well companies are committing to their ESG values via ratings performance, updated here regularly at KnowESG.