While voting and social media posts can go a long way in bringing about change. But at the end of the day, money talks.
If there’s no way to monetize it, there’s no will to prioritize it. But contrary to popular belief, ethics and investing aren’t always at odds.
Quite the opposite. According to data released earlier this year by research firm MorningStar, ethical investing strategies will likely outperform the broader market in the short (one year), medium (three years) and long term (10 years).
On top of promising, market-outperforming returns, those concerned with geo-political issues have found a real vehicle to pay more than lip service.
ESG ratings and sustainable investments
Providing capital to companies that align with investors’ moral ethos has become known as impact investing, activist investing, socially responsible investing, sustainable investing and ethical investing; its participants, activist investors.
To meet the growing appetite for business transparency, evaluation criteria is growing increasingly standardized – and comprehensive. This criteria is established, measured, and evaluated by third-party companies in the form of ESG ratings and reports.
What does ESG stand for?
ESG is an acronym for environmental, social, and governance. It is becoming increasingly requisite to evaluate companies on these three areas, consolidated into a composite score.
Drilled down, some of the specific dimensions assessed include:
- Environmental: pollution and emissions (operational or consumer), sourcing and use of natural resources, and impact on climate change
- Social: Employee management, potential social impact, stakeholder influence, product risk management
- Governance: Corporate culture and attitude, integrity and motivations of executive leadership, potential conflicts of interest
ESG composite scores are generally on a scale of 1–100. Companies with a score of one are presumably morally bankrupt, greed-driven companies run by Mr. Burns-like and the 100s who believe doing the right thing is also good business.
Do sustainable investments mean lower returns?
Companies with the highest ESG scores have outperformed this year, despite the exceptionally bullish run of the larger market.
Computer graphic processing designer NVIDIA (NASDAQ: NVDA) boasts a 99 composite ESG score – and over 140% return on investment year to date (at the time of this writing).
NVIDIA is hardly an anomaly.
The top five highest-scored ESG companies have outperformed the broader market’s returns by a factor of five (on the low end).
Even bottom-line-only investors can’t turn a blind eye to that.
Over the last twelve months, impact investing as a category has produced higher returns than the broader stock market at 23.4% compared to about 17.5% at the time of this writing. That suggests that the geo-political events of 2020 have accelerated market trends toward future-focused companies.That’s at odds with the assumption held by many investors (and apparently, the Department of Labor) that ethics are obstacles to business performance. On the contrary, ethics are predictors of success.
Socially responsible and sustainable investing ETFs
With the swell of interest in impact investing, large-scale asset managers including Vanguard and iShares have sponsored ETFs composed of high-scoring ESG companies.
If there’s a specific issue that is of particular importance to you – there’s an ETF for that.
Just to name a few:
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Climate change and clean energy
Clean energy ETFs have promising opportunities ahead as renewable energy continues its march on fossil fuels’s market share. Clean energy ETFs are in a good position to deliver for significant upside for activist investors. That’s even despite a long run of impressive gains.
The top-performing clean energy ETF year to date, First Trust NASDAQ Clean Edge Green Energy Index Fund (ticker: QCLN) is currently up over 172% year to date.
This is in part fueled by the monster rally in electric vehicle stocks, spearheaded by Tesla.
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Racial justice and equality
In 2018, the first ETF with a focus on minority empowerment (ticker: NACP) in companies was introduced with the sponsorship of the NAACP and MorningStar. The ETF invests its funds into companies that promote diversity and minority advancement. Year to date, it’s up 24.3%.
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Gender equality
Likewise, some ETFs invest in companies that promote gender diversification. MorningStar’s Women’s Empowerment Index is tracked by Impact Shares Trust 1 (ticker: WOMN) evaluates companies on criteria such as gender equity in leadership and policies that promote gender equality. Year to date, it’s up 24.7%.
Those returns are nothing to sneeze at, considering that during the same period, the SDPR S&P 500 Trust ETF (ticker: SPY) has produced 15.4% in returns in 2020.
Incorporating sustainable investments and and ESG focus into your portfolio
Whether for the greater good or for maximum ROI, the proliferation of sustainable investment options coupled with their outperformance of the broader market make impact investing an attractive option to incorporate into your portfolio.
You can find extensive data and reporting from sources you probably already rely on for investment insights, including Bloomberg, the Dow Jones, and MSCI.
Harvard Law School outlined some of the criteria various providers use here.
Come January 2021, and considering 2020’s ESG investment eclipsed 2019’s in June, we’re likely to see new data points and considerations in upcoming ratings and reports.
High returns and clear conscience: Too good to be true?
If impact investing ethics are important to you, be prudent. Dig a little deeper into sustainable investments, especially with respect to mixed-cause ETFs.
One of the most popular sustainable investing ETFs of 2020, the iShares ESG Aware MSCI USA ETF (ticker: ESGU) included investments in Exxon and Chevron – not exactly green companies. But high scores in the special and governance categories landed coupled with projected returns qualified them for inclusion.
The green wave
Despite some resistance, investors and asset managers are increasingly seeing ESG ratings as an integral part of risk assessment: After all, lawsuits, poor leadership, and bad PR can be real threats to the bottom line.
It’s hardly a fringe movement. Between 2011 and 2019, the number of S&P 500 companies that published reports on their sustainability practices rose from less than 20% to over 90%. Socially responsible business practices are not just nice-to-haves for prospective stakeholders – they’re table stakes.
Major investment firms from BlackRock to Citi have integrated sustainability considerations as routine due diligence.
“Every one of your analysts should have an ESG lens,” said Ray Joseph, former Global Co-Head of Investment Management at Citi Private Bank. “It should be embedded in the firm culture.”
If 2020 has taught us anything, it’s that we have some challenges to face.
But it’s these challenges that, if played correctly, can become the basis of a better future and prosperity.
And looking and the fundamentals, technicals, and hype factors – it might just be the most fiscally responsible thing to do.