What is ESG investing?

How to be a greener, more socially responsible investor

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Investing doesn’t have to only be about the money. There are several investment approaches that have gained popularity that aim to improve the world while still providing solid returns. One of the most popular is ESG investing.

ESG stands for environmental, social and governance, and ESG investing focuses on how businesses are prioritizing their impact in these three key areas. We’ll review how ESG works, how it is measured and whether it provides a good return.


Key insights

  • ESG investing focuses on companies that tout positive environmental, social and governance impact.
  • ESG companies are ranked by ESG ratings agencies to help investors find reliable companies.
  • ESG investors have enjoyed strong returns over the past decade, proving that ESG investing does not compromise investment performance.
  • ESG investing can be done through most online brokers and investment apps, with hundreds of funds and ETFs to choose from.

What does ESG investing mean?

“ESG is a methodology applied to investing,” said Marguerita Cheng, CEO of Blue Ocean Global Wealth in Gaithersburg, Maryland. “There are positive screens (aka inclusionary), meaning investors may want to be intentional about including certain types of investments. There are also negative screens (aka exclusionary), meaning investors may want to avoid certain types of investments.”

There are professional ESG ratings companies that rate companies to provide an ESG score, helping investors quickly see which companies are adhering to ESG practices.

Here’s how each ESG category breaks down:

  • Environmental: This category measures a company’s impact on the environment. This may include details about its carbon footprint, how it handles and disposes of waste or policies that are helping with climate change, among other measures.
  • Social: This category measures how a company provides positive social impact. This may include policies of equality and diversity, as well as helping with underserved communities. This may also include any philanthropic efforts tied to social justice locally, nationally and globally.
  • Governance: Governance is all about how a company is run, both from a policy perspective as well as a financial perspective. Ultimately, a company can score well in governance if it creates policies that affect positive change for employees and shareholders.

ESG investing is not exactly the same as impact investing, but is included in the impact investing strategy. While impact investing encompasses multiple approaches to investments that provide a positive impact, ESG is specific to the environment, social change and corporate governance.

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How is ESG calculated?

There are no laws defining what constitutes ESG, but there are ESG ratings agencies that set criteria to help measure how well a company is doing in all three categories. And some governing bodies have put forth proposals and criteria for measuring sustainability and other ESG impacts by companies.

There are many ESG ratings agencies, with the two most popular being Bloomberg ESG Data and S&P Global:

  • S&P Global offers a company search whereby investors can find out how individual companies have scored in the S&P ESG assessment.
  • Bloomberg has a more robust offering aimed at institutional investors, analyzing over 15,000 companies and thousands of mutual funds and exchange-traded funds (ETFs) to give each an ESG ranking.

Most ESG ranking systems are offered on a 100-point scale, with higher scores ranking better. Each category is weighted into the total score. For example, here are some of the categories considered by S&P Global when scoring a company for ESG features:

Environmental:

  • Building materials
  • Climate strategy
  • Environmental policy and management systems
  • Fuel efficiency
  • Low-carbon strategy
  • Recycling strategy
  • Resource conservation and resource efficiency
  • Sustainable forestry practices
  • Water operations

Social:

  • Philanthropy
  • Human rights
  • Labor practice indicators
  • Occupational health and safety
  • Social impacts on communities
  • Stakeholder engagement
  • Talent attraction and retention

Governance:

  • Codes of business conduct
  • Corporate governance
  • Customer relationship management
  • Health and nutrition
  • Marketing practices
  • Privacy protection
  • Product quality and recall management
  • Supply chain management
  • Sustainable construction
  • Sustainable finance

Returns on ESG investing

ESG investment returns vary by the type of investment chosen and your investment time horizon. While some well-rated ESG companies have not provided great returns, others have.

One of the best ways to measure ESG investing returns is by looking at an ESG index. Indexes are industry benchmarks that measure the performance of a group of companies.

For example, the MSCI KLD 400 Social Index measures the performance of the 400 leading ESG companies in the U.S. Over the past 10 years, this index has performed well, averaging 11% annual returns from 2012 through 2022. This performance nearly matches that of the popular S&P 500 index, indicating that ESG investing can still be competitive and profitable.

It’s important to note that an index investing strategy offers more diversification than investing in individual companies that are highly rated by ESG agencies. While a single company could outperform an index fund for a time, there is a higher risk of volatility and loss by picking individual stocks.

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How to start ESG investing

Investing in ESG companies can be done through most major online brokers and investing apps. Since ESG-rated companies are publicly traded, anywhere you can buy stocks, you can invest in ESG stock. You can search ESG scores through S&P Global’s search tool to find companies that you want to invest in and see how well they score.

The simplest way to invest in ESG companies is to find an ESG ETF or index fund that holds companies that are well-ranked by ESG ratings agencies. ESG index funds hold hundreds of highly ranked companies and are typically weighted by market capitalization.

For example, the iShares MSCI KLD 400 Social ETF (DSI) is an index fund that holds the 400 leading ESG-ranked companies by MSCI, and has a low 0.25% expense ratio. The top holdings include companies like Microsoft, Google, Nvidia and Tesla.

Another ESG fund is the Vanguard ESG U.S. Stock ETF (ESGV), which holds over 1,400 highly rated companies and has a very low expense ratio of 0.09%. This ETF seeks to mirror the performance of the FTSE US All Cap Choice Index, but excludes companies in certain industries that go against ESG values.

There are hundreds of ESG funds and ETFs to choose from, but it’s important to research how the funds are put together, which companies it holds and what the expense ratio is before investing.

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FAQ

Is ESG investing the same as SRI?

ESG and SRI (socially responsible investing) are not the same. ESG focuses specifically on environmental, social and company governance, while SRI focuses exclusively on socially responsible companies and investments. ESG has formal ratings agencies to help score companies, while SRI is more of an approach to investing, whether in companies or through private investments. There is some overlap between the two, but ESG is more formalized.

Is ESG investing profitable?

ESG investing can be profitable, depending on what you choose to invest in. Many companies that are highly rated by ESG agencies are also the top companies in the world, such as Microsoft, Google and Tesla. But investing in individual companies carries a higher risk of volatility and loss. Investing in ESG-focused ETFs and index funds has proven to perform well over the last decade, nearly matching the S&P 500 in some cases.

What are the risks of ESG investing?

If you are investing solely in ESG companies based on a third-party ranking, it may not be the best investing approach. Individual stock investing already carries a higher risk of loss, and choosing companies based on ESG scores without also reviewing financial information and performance can end up underperforming the market — or even losing you money. And while ESG investing is meant to make an impact, it’s sometimes difficult to tell whether your investments are truly making the impact you desire.

What is greenwashing?

Greenwashing is the practice of marketing a product or company in a false way to make consumers think that it is good for the environment. An example of this would include green labels and language on a cleaning product that uses harsh chemicals, but advertises itself as environmentally friendly. Companies that employ greenwashing tactics do so for profit and may try to associate with the SRI or ESG movement.

Bottom line

ESG investing helps investors find a way to make an impact while still earning a return on their investments. ESG ratings agencies have attempted to formalize ESG rankings to help investors find the best companies that are making environmental, social and governance impacts within the company and for the community at large.

Investing in ESG companies does not mean lower returns. In fact, ESG index funds have kept pace with more traditional index fund investment performance over the last decade. Picking companies to invest in solely on ESG rankings is not the best strategy, though, and working with a licensed financial advisor before choosing an ESG investment strategy is always a good idea.


Article sources

ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:

  1. MSCI, "MSCI KLD 400 Social Index (USD)." Accessed Nov. 29, 2023.
  2. iShares, "iShares MSCI KLD 400 Social ETF." Accessed Nov. 29, 2023.
  3. S&P Global, "ESG Scores." Accessed Nov. 29, 2023.
  4. Bloomberg, "ESG Data." Accessed Nov. 29, 2023.
  5. Vanguard, "Vanguard ESG U.S. Stock ETF." Accessed Nov. 29, 2023.
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