If you are serious about protecting the environment, then you need to make it a priority with every decision that you make. The recent coronavirus crisis should show us all how vulnerable our world truly is. While this epidemic will be temporary, the effects of climate change will be much worse.
You need to do your part in every facet of your life, which includes making socially responsible investments. This can help encourage companies to make eco-friendlier business decisions and contribute to ethical decision-making in other ways.
The Growing Importance of Socially Responsible Investing
In 2019, the global social responsible investments grew to $30.7 trillion. This figure alone may sound very impressive. However, the most impressive thing about this market is that it grew 34% in just two years. This massive growth was boosted by the rapidly growing concern about climate change.
However, many people don’t know how to make socially responsible investments. You need to do your due diligence, so you don’t unintentionally support a low-quality company with a lousy track record for social responsibility.
Currently, there are several different investing philosophies within the larger responsible investing realm. One philosophy that you may have been hearing about is ESG investing. The letters ESG stand for environmental, social, and governance.
Investors in ESG funds analyze stocks by looking at the environmental, social, and governance criteria. Any aspiring investor can become part of the quickly expanding ranks of ESG investors. All you need to do is learn more about the framework and apply it when making your future investing decisions.
In this comprehensive guide, we’ll tell you all you need to know about ESG investing. Read on to learn more.
What Is ESG Investing?
ESG has its roots in socially responsible investing (SRI). In SRI, the money isn’t invested in companies involved in practices that aren’t socially and environmentally responsible.
The earliest instance of SRI dates back about two centuries ago when the Methodist movement objected to putting money in companies involved in the manufacture of arms, tobacco, and so on. Later, in the 1960s, a similar movement emerged, this time due to the Vietnam war.
The term ESG was first used in the UN PRI report of 2006. The report outlined that financial evaluations must incorporate ESG criteria going forward. Today, the PRI has 1600 members with assets worth more than $70 trillion.
You can learn here about the key drivers of ESG growth.
How Does ESG Differ From SRI?
ESG and SRI are often confused, and it’s easy to see why. Both frameworks, after all, focus on the wider environmental and social implications of an investment. However, there are major distinctions between the two philosophies.
Besides considering most of the same factors that SRI does, ESG also looks at how a firm’s adherence to such factors might impact its performance on the market. SRI, on the other hand, goes beyond considering the social and environmental effects of investment to calling for active refusal to invest in certain companies.
Types of ESG Funds
All exchange related funds and mutual funds must publish a guide on their investment strategy, its costs, who runs the fund, and what its risks are. That said, let’s look at some of the different types of ESG funds today.
ESG Consideration Funds
Many companies say that ESG factors are important considerations in their investment strategy. Beyond that, however, these funds don’t apply impact analysis, exclusionary screens, or shareholder engagement as part of their process. These funds are known as ESG consideration funds.
ESG Focus Funds
These funds feature sustainability as a formal part of their process when doing portfolio construction or security selection.
Impact funds focus on broad sustainability. They also consider delivering social and environmental impact besides financial returns. Typically, impact funds focus on specific themes like gender equity, low carbon, or green bonds.
Sustainable Sector Funds
These ESG funds focus on stocks belonging to companies with a clear contribution to the transition to green economy. These companies usually focus on renewables, environmental services, energy efficiency, green real estate, and water.
How to Incorporate ESG Into Your Portfolio
There are many different ESG strategies out there you can choose from. The thing to remember is that none of these strategies can fit everyone. That’s why you need to take the time to research about these approaches and decide which one will work for you.
Negative and Norms-Based Screens
These are perhaps the most common ESG approaches today. The first approach means entirely avoiding stocks of companies that deal with certain products, such as guns. The latter focuses on compliance with standards established by the United Nations Global Compact, OECD, and other international bodies.
ESG integration has gained lots of property in recent years. The approach involves evaluating a company’s profile when thinking of whether or not to buy their stocks. The approach involves assessing the potential gains and risks of buying a stock based on the company’s profile.
You can decide to analyze the company’s profile independently or use agencies that issue ESG scores.
ESG-Focused Shareholder Activism
This form of investing entails buying the stocks of companies considered reprehensible by other SRI investors. The expressed purpose of doing so is to demand or encourage these companies to improve.
Shareholders use such engagement tactics as proposals, talking directly to executives, and attending annual general meetings. This approach doesn’t necessarily involve the intention to make money. Once the shareholders have made sure that the company is addressing the necessary issues or has fully met their demands, they sell their shares.
As an impact investor, you put your money in a company that has demonstrated impressive social and environmental impact, besides positive financial returns. Some impact investors aim for below-the-market-rate returns, while others expect returns comparable to or better than the market.
You can decide to put your money where the expected return is in a highly impactful area like sustainable agriculture. In this case, you’re not aiming for a substantial financial outcome. Instead, you’re aiming at seeing measurable progress in your desired area.
You’ve probably already heard of this buzzword. It’s a strategy that aims at aligning a business with all stakeholders. The objective is to share the success enjoyed by the company.
A company that engages in conscious capitalism isn’t seeking profits for the shareholders alone but also aims at serving employees, customers, supplies, the environment, and the community. By serving all stakeholders, the company gets stronger and can generate long-term success.
Is ESG Investing Right For You?
It’s no secret that ESG funds have gained tremendous traction over the years. Investors who use this strategy can significantly cut portfolio risk, generate higher returns, and ultimately feel better about their stocks.
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