Understanding ESG investing strategies

Lately I have been hearing the term “ESG investing.” What does it mean?

ESG investing refers to investment strategies that are consistent with environmental, social, and governance best practices. You will also hear the terms socially responsible investing, sustainable investing, green investing and impact investing that generally refer to the same thing, though there are nuances in the terminology. The term ESG seems to be an all-encompassing term, where some of the others have a slightly narrower meaning. While some of the terminology surrounding the subject is relatively new, the origins of the investment focus actually began in the late 1800's when the approach was primarily about avoiding "sin stocks" in portfolios held by religious organizations. However, it didn't gain widespread attention until the 1970s when such highly charged political issues such as the Vietnam War and apartheid in South Africa led some investors to try to prevent their money from supporting policies that were counter to their beliefs.

In recent years, the concept has evolved into a much more comprehensive strategy. ESG is no longer merely about the passive avoidance of companies in industries such as tobacco or firearms. Instead, the emphasis is on finding companies with certain quality attributes such as environmental and product safety, workforce diversity, employee retention and strong corporate governance; qualities that will likely have a positive impact on future shareholder value. This broader focus coupled with increased interest from the investing public, especially Millennials, has led to a larger number of highquality ESG investment options within and across asset classes. As a result, ESG has grown not only in assets under management, but also in the number of choices being offered.

The trend toward ESG investing is gaining momentum. More people want ESG in their portfolios and continued growth is likely to come from a number of different sources, including institutional investors. University endowments are responding student demands for fossil fuel divestment and foundations are coming to see ESG as a way to extend their influence on issues that they care about.

While ESG investing is growing in popularity, it does have its own set of challenges. Some investors, especially on the institutional side, believe that ESG limits the universe of investments, which in turn limits potential performance opportunities. In addition, while it is true that the number of ESG investment options is growing, the universe of ESG managers remains small and undiversified relative to the universe of nonESG managers. It may be getting easier to build an entire ESG portfolio diversified across asset classes, but it's still not easy. While the choice of investments may not be limited, the choice of institutional quality investment managers with an established track record, it still is limited in relative terms. While ESG is definitely growing in terms of the number, type and quality of choices, there is still a broader manager opportunity set outside of ESG, particularly in certain asset classes. This makes it challenging to build a portfolio that is 100 percent consistent with ESG principles.

Investors ultimately will have to decide for themselves whether or not they are interested in ESG investing. Are your goals strictly financial, focused on rate of return and risk management or do you prefer to incorporate an element of "social good" to your investment strategy? If not, you have a much broader range of options to pursue. If so, make sure your expectations are clear and realistic. Many ESG investments have the potential to produce solid financial returns. Though past performance is no guarantee of future results, you should have a sense of what kind of return you might expect. You shouldn't feel you have to expect mediocrity in order to support your beliefs. Monitor your investment's performance and be prepared to look elsewhere if your investment doesn't continue to meet your needs, either financially or philosophically.

The clearer you are about the goals you have for your money, the better your chances of selecting appropriate investments.

Bryan Hickingbottom is a financial advisor with Raymond James Financial Services Inc., in Lodi. If you have any questions for our panel of financial experts, email NewsSentinel Editor Scott Howell at scotth@lodinews.com or call 209-369-7035.