Investors must consider potential trade-offs when going down the responsible investing route
Socially-responsible or ESG (environment, social, governance) investing is now seen as the best way to make money – and feel good about it. But, more than any other type of investing, you need to look at the pros and cons to determine if you’re making the impact you want.
What is socially responsible investing?
It’s when you strategically invest in companies that have ethical practices. If you’re interested in supporting green technology, you may want to invest in companies that make solar panels. Or, if you want to encourage healthy eating, you may want to invest in companies that support local, organic farm products.
These days, the biggest question around socially responsible investment is whether you’re actually getting what you think you’re buying. That’s particularly critical for those who want to live out their values, whether it’s being better environmental stewards to impact climate change, supporting globally ethical businesses that create healthy products and services, or furthering a diversity agenda to promote more equity for all.
There was a time when ESG investments didn’t provide much return, so only the die-hards bought them. Now that more are providing better returns, it’s important to look at the pros and cons of ESG investing with this primer as you consider the potential trade-offs of ESG investing.
1. Choosing your issues
What’s important to you? What do you want your money to do to support your values? It’s worth taking an inventory and picking out your top issues. But, limit how many you choose so you can make the most impact with your resources rather than spreading them too thin.
If a family member has had a heart attack, for instance, you won’t want to support the tobacco industry. If you’re anti-war, you’ll likely avoid companies that produce tanks and missiles. If you’re concerned about healthy development in third-world countries, you may want to support companies that bring clean water to them as that can be a key foundation for its progress.
The advantage of choosing a few options is that your investment can make more impact in rewarding the companies that support what you value and withholding funds from those who don’t. That can result in change. Take Lego, for instance, which ended its partnership with Shell Oil a few years ago and now partners with companies like the World Wildlife Foundation on social initiatives. It’s also committed to reducing its carbon footprint and it’s working toward having 100% renewable energy capacity by 2030. You can make a difference.
2. ESG may mean sacrificing returns: lower returns or higher risk
When you limit your investment options and pay more to include your ESG factors, you may give up on some investment return as you narrow the field that can provide you with returns. Many have written on why this kind of sustainable investing can feel like a money pit because the funds you favor can underperform compared to others that are less socially responsible and perhaps less risky, too.
Take time to do your ESG research and find companies that not only align with your values, but have the best returns, as there may now be more than one option to choose from if you spend time researching upfront before you invest.
3. Slightly higher fees
You may have to pay a little more in management fees for some ESG funds, which can also eat into your earnings. That’s because ESG funds require managers to do research and they’re often working with a smaller asset base, so you may pay more to be in their funds.
But, as one study showed, 66% of people around the globe are willing to pay more for sustainable goods. That number jumped to 73% with millennials. It’s always smart to focus on performance, but if you’re doing your research, you may discount the extra cost knowing that you’re investing in a higher cause.
4. No reporting requirements
While there are different analytic firms that can rate stocks on the socially responsible scale, the biggest pitfall these days in the ESG investment process is that there are no standards or ESG ratings to measure these funds’ performance. So, they can market themselves as good for the environment, but they may not be, and if you start comparing companies, it may feel like apples and oranges. You don’t have a way to tell because there are no reporting requirements and what is self-reported isn’t consistent across industries or companies since there is no universal standard.
It’s one of the biggest challenges that portfolio managers now face and one they hope will eventually be rectified with standards, better data, or some indicators that can help them prove a fund is accomplishing all that it claims. For now, you need to approach each fund with some scepticism and check what you can, knowing that you can’t confirm all the pros and cons that its portfolio management may claim.
5. Non-transparent companies
It’s hard to know what companies to pick because they may not be transparent about all that they do, so it may be hard to figure out how those align with your different values. You may nix a large cell phone provider that uses non-biodegradable material that contributes to pollution, but then discover that it’s proactive in promoting diversity or helping women rise into its managerial roles. The more you research, the more you’ll find out, and the easier it will be to satisfy those values that you chose when you picked the issues you wanted to support.
ESG investing is a growing area, so some of the five issues that we’ve identified may be addressed in time. In the meantime, pick your causes, do your homework, and then balance the potential trade-offs of ESG investing with the satisfaction that you get from making your money not only work for you, but for the greater good of the larger society around you.