You may have heard the term “vote with your dollars” when you shop – the idea is that you can support products and brands you like when you spend your money. The same concept can apply to investing.
Around the world, many individuals as well as big institutions (such as pension plans) are including environmental, social and governance (ESG) factors when making investment decisions. This has led to a substantial increase in the number of opportunities to invest in companies believed to have sustainable business practices.
Why ESG Investing Is Becoming Popular
While not new, ESG investing has grown rapidly in the past few years. As of the second quarter of 2021, funds focused on ESG-related issues had assets of $2.3 trillion globally.1
And ESG investing is popular with investors who are interested in companies that will generate profits and positive outcomes in the world. According to a recent Harris Poll conducted for CNBC, 76% of older millennials think climate change poses a serious threat to society.2 ESG investing recognizes that if society is threatened, business profits are at risk.
In another recent survey, more than half of those who responded said they believe investment managers should sell their shares of companies with poor ESG records.3 Trends like these are making corporate managers sit up and take notice, which supports the idea that ESG investing has the potential to make a difference.
What Does ESG Mean?
The term “ESG” refers to environmental, social and governance factors that investors may want to consider when analyzing an investment opportunity. The concept has been around since at least 2006 when the United Nations’ Principles for Responsible Investment report outlined standards to help investors incorporate ESG factors into investing.4 These factors can represent strengths or risks that impact a company’s long-term sustainability.*
Environmental. How do a company’s actions affect the environment? This may include its carbon footprint, recycling efforts, use of toxic chemicals, renewable energy usage and the extent to which it discloses information about these issues.
Social. How does the company treat its employees, its suppliers, the communities where it operates and society overall? This includes employee benefits and safety, diversity and inclusion efforts and promoting ethical behavior in its supply chain.
Governance. Does senior management uphold laws and ethics rules? Does the board of directors represent shareholders, even if that means standing up to the CEO? Good governance can prevent scandals that can tarnish a company’s reputation for years.
Types of ESG Investing to Choose
ESG investing comes in various “flavors,” and frankly, just having “ESG” or “Sustainable” in a fund’s name does not say much. Some ESG funds pay equal attention to E, S and G, while others emphasize one category over the others.
Some funds rely on a third party’s scores or ratings of companies’ ESG-related behaviors to choose or reject stocks. Other funds analyze a company’s overall ESG profile along with financial data and other information when making investment decisions.
Another approach is to screen out certain industries, such as tobacco or oil and gas, giving investors a way to invest in funds while avoiding companies whose activities conflict with their personal values. Of course, the returns offered by these funds could be quite different from the returns on the S&P 500® or other broad-market indices that include those industries.
There are even “green bonds” that companies and municipalities issue to borrow funds for specific environmentally friendly projects.
ESG ETFs and Mutual Funds
ETFs and mutual funds are two popular vehicles for ESG investing:
ETFs. An ESG exchange-traded fund (ETF) holds stocks (or bonds) of various companies that satisfy the fund’s stated ESG criteria. You could invest in a sustainable growth ETF, an ETF focused on diversity and inclusion or one that is highly specific, such as focused on electric vehicles. Some ESG ETFs simply “copy” the S&P 500, then remove stocks that do not align with the fund’s objectives.
Mutual funds. Like ETFs, ESG mutual funds can hold stocks or bonds (or both) that mutual fund managers determine fit the fund's stated ESG criteria. As noted above, a fund may look at a wide range of sustainability factors or focus on a specific category.
There are many choices in the world of sustainable or ESG investing, and it can help to have a financial advisor by your side to review the fine print and help make a decision that is right for you.
Is ESG Investing for You?
The growing interest in and wide array of choices among ESG-focused investments suggest that you don’t have to sacrifice return potential to invest in a way that reflects your values. And, as more companies consider ESG-related risks and opportunities as an important part of how they manage their businesses, sustainable investing could be viewed as the norm in the not-too-distant future.
Whether buying shares of ESG ETFs or working with a financial advisor to create an investment portfolio tailored to your beliefs, it is possible to put your money where your values are, directing your investing to help make a positive difference in the world.
Learn more about ESG investing and whether it makes sense for your own investment strategy.
Patturaja Murugaboopathy and Simon Jessop, Global sustainable fund assets hit record $2.3 tln in Q2, says Morningstar. Reuters, July 27, 2021.
Alicia Adamczyk, Millennials spurred growth in sustainable investing for years. Now, all generations are interested in ESG options. CNBC Make It, May 21 2021.
Ted Godbout, Interest in ESG Investing Isn't Limited to Millennials. NAPA, November 15, 2021.
Betsy Atkins, Demystifying ESG: Its History & Current Status. Forbes, June 8, 2020.
Many of American Century's investment strategies incorporate the consideration of environmental, social, and/or governance (ESG) factors into their investment processes in addition to traditional financial analysis. However, when doing so, the portfolio managers may not consider ESG factors with respect to every investment decision and, even when such factors are considered, they may conclude that other attributes of an investment outweigh ESG considerations when making decisions for the portfolio. The consideration of ESG factors may limit the investment opportunities available to a portfolio, and the portfolio may perform differently than those that do not incorporate ESG considerations. ESG data used by the portfolio managers often lacks standardization, consistency, and transparency, and for certain companies such data may not be available, complete, or accurate.
Sustainable Development Goals (SDGs) are a collection of 17 global goals set by the United Nations General Assembly. They were developed by a global team of industry and government leaders and adopted by all 193 member states. The SDGs include 17 goals and 169 attendant targets aimed at solving some of the world’s most pressing problems by 2030. The goals include eradicating poverty, providing environmental resources and achieving gender and income equality.
This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.