ESG: Investing with a Voice August 26, 2021
Social justice advocacy and activism of all stripes is nothing new in the United States. Over the last year, we have seen some of the strongest pushes for social justice in decades gain traction and score results throughout our nation.
The continued and growing dialogue for impactful change has stretched beyond the visible and organized advocacy covered in national media outlets. People are starting to look for ways to effect global change in many different aspects of their lives. What has grown is an expectation that how we spend our money should reflect our values.
Socially responsible and sustainable investing is nothing new. It has been around much longer than media headlines lead us to believe. The difference now is changes in technology, social and cultural environments, and the expectation that these options need to be available to increase investor participation.
Socially responsible investing (SRI) and sustainability investing (SI) have until recently been relative outsiders in the investment landscape. These options were primarily utilized by organizations that have a social cause and/or mandate to exclude certain exposures to companies that directly conflict with the mission or belief structure of the organization. An example of this would be the American Cancer Society not investing in tobacco companies (American Cancer Society, INC, 2019). Excluding companies from an index fund was initially very costly, and it brought with it the risk of underperformance when factoring in the overall net cost to operate the investment.
In many cases, the minimum required amount to invest in this way was a significant barrier for the retail investor. As technology improved, though, the cost of operating specialized investments that consider different kinds of social and sustainable environmental exclusions began to decrease, which resulted in the expansion of such options. In addition, as interest in social and environmental impacts grew beyond organizationally specific exclusions, a more unified and far-reaching scoring system for companies needed to be developed.
To spare the reader from parsing the lengthy history of this development, I’ll fast forward to the formation of environmental, social, and governance (ESG) investing.
The creation of an ESG scoring system did not immediately result in broad options for the average investor. Most likely, the term ESG was not known by the average person in 2006. Asset inflow was minuscule compared to traditional investing, and in some years, there were more outflows from than inflows into ESG-related investments. (In the world of investing, inflows are crucial to grow and maintain a voice within the financial sector.)
In 2019, ESG investing made a giant step to the mainstream, with an inflow of $20.6 billion (compared to $5.5 billion in 2018) (Atkins, 2020). This momentum increased in 2020, with over $51 billion in net inflows, and we are seeing the momentum continue in 2021 (Jon Hale, 2021). It is safe to say that the financial markets have taken note that people want to invest based on their values, and that the demand for options is not going away anytime soon.
If you have made it this far in the article, then you most likely have some interest in value-based investing that utilizes ESG criteria. If so, there are some things you should know. There are two routes you can take when looking to invest with ESG criteria: on your own or with a financial advisor.
Investing in ESG on your own.
Unfortunately, the financial industry is not as transparent as we would all like – and that’s coming from someone who works in the industry. So there are certain things to keep in mind when looking to put your hard-earned money into a vehicle that will make it grow.
As with most things, cost is important. We have seen the rollback of most major brokerage houses’ trading costs (Schwab, TD Ameritrade, Fidelity, etc.), but that does not always apply. When researching the right investment vehicle, be sure to check if there are trading costs associated with investing in a mutual fund or ETF (exchange-traded fund).
To elaborate, all investments have internal costs called “expense ratios.” These pay the people that manage and operate the fund. You do not see these expenses, but they are taken out of the net performance of the investment. The higher the expense ratio, the lower the net return you will receive, compared to a lower-cost counterpart. You can research expense ratios of investments using online tools, such as Morningstar, or on the investments’ websites.
The number of holdings in an investment is important, too. If the fund has less than 100 holdings, it might be riskier and less diversified than other options out there. The same holds true with the fund’s inception. If it has been around for less than three years, then it might not have the track record and longevity that is appropriate for your investment needs.
There are other factors to keep in mind, and I highly recommend that if you choose to invest on your own that you take the time to do the research and fully understand all the risks involved with capital market investing.
Investing in ESG with a financial advisor.
In my opinion, the two most important factors to ensure that your financial advisor is aligned with your best interests are being a fiduciary and being a fee-only advisor.
If you are trusting a professional with your hard-earned money, they should be required to be a fiduciary, that is, act in your best interest at all times. Some financial advisors have the ability to choose when they operate under a fiduciary standard or a suitability standard, and I strongly recommend only working with someone that always has to act as a fiduciary.
A fee-only advisor is different than a fee-based one. A fee-only advisor can only assess a fee based on the assets that they manage, and they should not be charging commission or receiving financial kickbacks from companies to provide their product and/or services.
Not all advisors have familiarity and experience with ESG investing. Entrusting someone with your money requires a lot of trust and confidence, so you should take the time to determine if they have the experience in the type of investing that reflects your values.
The initial dialogue with an advisor to determine if the relationship is the correct fit should be free and without pressure. If the initial consultations cost money or you feel like you’re pressured to decide in that moment, that is a good indication you should explore other options.
Investment activism is nothing new. What we have seen with the rise of ESG investing over the last few years, however, is that a new activist investor is emerging, one looking to put their money into companies that reflect the changes they want to see in this world, and they wish to do this with an expectation of accountability.
You now have the option to make significant changes with your investments, and corporate America has taken notice.
“American Cancer Society, INC. (2019). Financial Statements. Retrieved from https://www.cancer.org/content/dam/cancer-org/online-documents/en/pdf/policies/2019-Consolidated-Financial-Statements.pdf
“Atkins, B. (2020, June 8). Demystifying ESG: Its History & Current Status. Retrieved from www.forbes.com: https://www.forbes.com/sites/betsyatkins/2020/06/08/demystifying-esgits-history–current-status/?sh=312ad0912cdd
“Jon Hale, P. C. (2021, January 28). A Broken Record: Flows for U.S. Sustainable Funds Again Reach New Heights. Retrieved from www.morningstar.com: https://www.morningstar.com/articles/1019195/a-broken-record-flows-for-us-sustainable-funds-again-reach-new-heights