ESG Investing: Executive Summary
Environmental, Social, Governance or ESG investing is a term encapsulating the following related investment categories:
- socially responsible investing
- responsible investing
- impact investing
- ethical investing
- values investing
- green investing
- sustainable investing
- Investment issues in corporate governance such as gender and ethnic diversity in addition to pay equity in all areas of management.
While in the same arena, every one of these investment strategies can be slightly different, identical, or they can be rolled up into one fund. It is a complex area. Making this even more confusing is that we, in the industry, use many of these terms interchangeably. But the investment business appears to have settled on the term ESG as the catch-all description.
What does it mean? A useful summary comes from the Financial Times:
“The definition ESG (environmental, social and governance) is a generic term used in capital markets and used by investors to evaluate corporate behavior and to determine the future financial performance of companies.
ESG factors are a subset of non-financial performance indicators which include sustainable, ethical and corporate governance issues such as managing the company’s carbon footprint… [1]
There are different investment vehicles to funnel client funds into ESG investments, but much of ESG investing is done through the purchase of mutual funds, either open-ended or ETFs. Those of us in the trade know that on Wall Street if something is worth doing, it is worth overdoing, so there are approximately 636 ESG funds according to the US SIF (Social Investment Foundation). [2] However, Morningstar says there are 275 ESG funds. [3] This difference underlines a common issue in the world of ESG investing: authoritative sources give different numbers of both funds and assets under management.
There are also many different ways of defining what is and what is not an ESG fund based on the equities the fund purchases. One person’s ethical investment is another person’s unethical investment. Consider a corporation which builds warships for the US Navy and even works with the navy on pilot programs to power ships using biofuels. [4]
This company could have an excellent ESG record, and many clients would approve this company as an investment while others may not approve of purchasing shares in a company which produces military hardware. This points out the need to understand the lens through which a client determines what characteristics qualify an ESG candidate as acceptable in meeting their criteria, before making a recommendation. Better yet, be as explicit as possible when constructing the investment policy statement to ensure alignment between expectation and execution.
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Contributing Writer: Subject Matter Expert Charles McCain
Resources:
[1] http://lexicon.ft.com/Term?term=ESG