Environmental, Social and Governance (ESG): A Hot Topic for Investors
By Tanya Rapacz, CFP(R)
In 2020 and continuing through today, there has been an explosion both in interest in and offerings of ESG investing.
First of all, what is “ESG” investing? ESG investing is defined as making investment decisions considering certain factors in addition to more traditional financial factors. The additional factors are:
E – Environmental
S – Social
G – Governance
Some examples of focus in each category are:
- Environmental: climate change, sustainability, energy efficiency, and water use.
- Social: working conditions, labor practices, equal opportunities, diversity, and equity.
- Governance: executive pay, board independence, transparency, and corruption.
There are investors who gravitate towards specific companies (or mutual funds or exchange traded funds) because they want their investments to be consistent with their own personal values, either to “do no harm” or to promote a certain cause or world view. For example, it is possible to buy a mutual fund that avoids gun companies or one that invests in companies that promote clean energy technology.
Increasingly, we have been hearing from investment managers that have created funds that screen for companies that as a way to potentially reduce risk and enhance return. They are making the case that these screens should be considered even by investors whose sole purpose is financial performance.
Why? Consider how a manager might evaluate companies with a strong governance rating versus companies with a lower governance rating, as determined by how independent the board is. A company with an independent board could make it known that they plan to take an active role in guiding that company towards avoiding regulatory and reputational risk that could negatively impact share price in the short and the long term.
Many investors agree. According to Morningstar, net investments into ESG funds outpaced flows into non-ESG funds for the first 6 months of 2021. (Source: July 22, 2021. Morningstar.com “Funds Flows 2021” Holly Black and Bhavik Parekh).
Up Next: How do we see ESG at Arthur Stein Financial?
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