Every company has a different prerogative, but some prioritize operations and initiatives that improve society. Individuals who want to invest in those types of companies can engage in what’s called ESG investing. Also known as environmental, social, and governance investing, ESG investing gives people the chance to put their dollars in companies that align with their personal values. That said, ESG investing has its challenges such as expensive fees and a lack of standardized data, which investors need to make informed decisions.
What is ESG Investing?
ESG investing is about putting dollars in a company that meets certain criteria relating to social good. Investments are given an ESG score, which measures how sustainable the investment is and the social impact it has.
This type of investing can be a way to hold companies accountable and also a way for investors to put money into companies that have the potential to create positive impacts long-term. The idea is also that a company holding itself to ESG standards is likely built on a strong foundation and will perform well over time. Some investors see those companies as a worthwhile investment to make.
ESG Criteria
There are three categories used to evaluate a company and determine whether their stock qualifies as an ESG investment.
- Environment: This criteria focuses on how a company impacts the environment. Common factors to consider include air or water pollutants, carbon emissions, deforestation, waste management, or toxic chemicals.
- Social: While social impact can be vast, some factors this criteria looks at include DEI efforts like racial diversity, LGTBQ inclusion, or how a company amplifies other social good initiatives. Sexual harassment policies, human rights initiatives and gender equality policies can also fall under the social umbrella.
- Governance: The governance criteria focuses on how internal operations make a positive impact. For instance, it could assess how diverse board members are, how much executives make, and internal corruption.
ESG scores are calculated by research firms such as Bloomberg, S&P Dow Jones Indices, JUST Capital, MSCI and Refinitiv. The scores typically use a 100-point scale, with the higher scores being better. Keep in mind that there is no uniform score as each research firm uses different metrics.
Pros and Cons of ESG Investing
ESG investing may seem like it should be in everyone’s portfolio, but there are some downsides to keep in mind. One is that they can be expensive investments. More specifically, ESG funds sometimes have higher than average expense ratios because of the research and time that goes into this type of investing.
Another con is that ESG investing criteria isn’t standardized or tracked by an index as mentioned above. The downside here is it can be challenging for investors to accurately compare companies and make informed investing decisions. Since there is no standard for this new category of stocks, it can be relatively easy for companies to portray themselves as ESG focused without providing the benefits that you’d expect based on their ESG score.
For example, companies can purchase carbon offset credits so that they can portray themselves as low-emitting or carbon neutral. However, carbon offset credits can be misleading in themselves. The funds used to purchase carbon offset credits may not be actually offsetting carbon emmissions to the extent you’d expect. Carbon offsets are a relatively new concept and are not standardized or effectively regulated.
The upside of ESG investing is that individuals can put their money in companies that are making the communities or the broader world they live in better. For some, this investment is worth any of the tradeoffs mentioned above.
If investors are concerned about investing in companies that don’t fit their belief system or world views, they could consider simply removing those specific stocks from their portfolio rather than purchasing an ESG fund. That level of customization is another benefit of owning stocks and bonds directly, rather than through a pooled mutual fund or ETF.
How to Get Started With ESG Investing
To get started with ESG investing, research is vital. Some companies have an impact report; investors can use this to assess how much social impact companies are making. Consider looking into other factors like revenue, net income, or work environment via Indeed or Glassdoor. Screening tools can also be a way to sift through ESG investments.
As with any other stock, having a brokerage account is essential. Subsequent steps include finding the ticker symbol of the company and then purchasing the volume of stock you’re interested in. Stock aside, it’s possible to invest in ESG mutual funds and ESG ETFs if cherry picking stocks isn’t appealing. Keep in mind that not all brokerages offer ESG investment options.
Those who do decide to opt for ESG investing should remember the importance of a well-diversified portfolio and avoiding one heavily concentrated with ESG stock.
