Environmental, social, and governance (ESG) investing has become a hot topic in the finance world in recent years. What is it and is it a good idea? Here's everything you need to know:
What is ESG investing?
ESG investing is "making investment choices that emphasize social and environmental responsibility alongside profits," according to NPR. An investor evaluates potential companies based on how well they fulfill their environmental and social responsibilities, which collates the findings into an ESG score. Some factors that influence a company's score are carbon footprint, level of diversity, and political contributions. More broadly, investing through the lens of ESG means looking at "how a company serves all its stakeholders: workers, communities, customers, shareholders, and the environment," explained Forbes.
ESG scores are assigned by research firms, explained Linda Zhang, senior advisor at online banking company SoFi and CEO of Purview Investments. "The rating firms tend to rely on multiple criteria to evaluate each of the individual E, S, and G components." Some famous ESG research firms include Bloomberg and JUST Capital. Individuals can also decide how they want to invest based on their own analysis and criteria.
"At its core, ESG investing is about influencing positive changes in society by being a better investor," said Hank Smith, Head of Investment Strategy at The Haverford Trust Company. He added that this form of investment assumes that ESG factors improve a company's bottom line. But ESG investing isn't without controversy.
Why is ESG controversial?
The debate revolves around the question of whether it is just another form of greenwashing. ESG investing is "designed almost entirely to maximize shareholder returns, falsely leading many investors to believe their portfolios are doing good for the world," Hans Taparia, a clinical associate professor at the New York University Stern School of Business, argued in The New York Times. Firms like Meta, Alphabet, and — "most egregiously" — BP and Exxon have "respectable" ESG ratings, Taparia said. Indeed, Coca Cola Co. is labeled an "ESG leader" even though its "single-use plastic production is responsible for more pollution than any other company in the world," said The Motley Fool.
But that doesn't mean ESG investing has no merit. Some research suggests ESG investments may be more stable than others. As Investopedia explained, ESG investors might be able to "avoid the blowups that occur when companies operating in a risky or unethical manner are ultimately held accountable for its consequences." Data from 2022 also speaks to the robust nature of ESG products, which "managed to perform in line with the general market" in a very volatile year, while also attracting new money, "a good sign for the future of responsible investing," concluded CNN Business.
ESG investing is also a way to support causes like workers' rights and climate action in your own way. Investors can "make sure that they don't invest in firms that exacerbate or contribute to these problems and would rather invest in those that are champions in leading ESG movements," remarks SoFi's Zhang.
The key, as with all investing, is to do so responsibly.
How can I get into ESG investing?
Start by determining your personal ESG values, as well as doing some research. Through a brokerage account, you can invest in individual stocks yourself, or in ESG funds. Purchasing individual stock is good if there is a specific company you have in mind. Check out their impact report, "which will highlight any sustainable or cultural initiatives they've implemented and how they handle issues such as carbon emissions," NerdWallet said. But "funds can fill out your portfolio quickly, and can diversify your holdings instantly," the personal finance site added. When investing in an ESG fund, there is an expense ratio to consider, meaning "you may be paying a slight premium to invest in funds that are targeting ESG criteria," per Forbes. These ratio aren't as high as they once were, explained Mike Walters, CEO of USA Financial, "but they are still higher than other funds on average."
Sometimes it is difficult to determine what would make good investments starting out. Novices can enlist the help of a robo-advisor that will "build and manage investment portfolios based on your risk tolerance and goals," per NerdWallet. Some examples include Betterment and Merrill Edge Guided Investing. If using a robo-advisor, it is important to research how the advisor makes investments because each will vary. But it can be a low-cost and simple way to get into ESG investing without lots of knowledge or experience.
You can also hire an ESG financial advisor who can help create a portfolio tailored to your values and financial goals.
Rachel Robasciotti, founder and CEO of Adasina Social Capital advises asking questions such as: "What's the issue you care about or want to have an impact on? How are you measuring that issue and your impact? And who are you working with to do that?" It is also important to remember that just investing isn't necessarily enough to pressure companies to improve their behaviors, and that political action is required to create substantial social change, said Vox.