No matter the state of the economy, investors are always concerned about where their money is going and how it’s doing. It doesn’t take someone with a psychology PhD to figure out why. So when a company says it focuses on ESG, it’s understandable for investors to be skeptical, wondering how such an approach actually helps their bottom line. Is ESG investing more about seeming “woke” than making money? Is it a political fad that will die out and leave individuals with portfolios that weren’t designed to maximize returns?
The answer to these questions is an emphatic, “No!”
This blog post aims to clear up the misconceptions and misinformation floating around about ESG, and to explain how it’s actually a sound investment analysis approach used by wealth managers to help potentially boost your portfolio profits and your tax savings.
OK, so is ESG investing “woke” or what, exactly?
There’s a lot of political banter in the media causing confusion about what it is, and leaving investors wondering, is ESG investing “woke”? In literal terms, ESG stands for “Environmental, Social, and Governance.” These are the three pillars of ESG investing. “Environmental” does indeed focus on the environment as one would expect, analyzing how a company’s behavior affects carbon emissions, pollution, energy efficiency, and so on. Social, too, is based on some unsurprising issues, such as human rights and labor standards, but also encapsulates very business-focused issues like data protection policies and customer satisfaction. Governance is about how a company is run, and comprises everything from board composition and executive compensation to lobbying, political contributions, and bribery and corruption.
As you can see, some — but not all (!) — of these issues could be filed under “doing good” without any clear evidence of how they might affect financial performance. But they are not just here to further any sort of political agenda. ESG analysis takes a look at these factors in order to assist in evaluating an investment’s connections to risk, opportunity, and expected financial performance — and these reasons, not the political ones, are the key ones considered in ESG investing.
The dismissal of such an investment analysis approach as “woke” is simply a byproduct of our divisive times — where “wokeness” of all kinds is attacked to score political points — rather than a reflection, or understanding, of the reality of ESG investing.
Besides not being “woke,” what else isn’t ESG?
Before we go on, we have to clear something up: Investing based simply on social good — as in, putting money into companies that aim to impact society in a positive way, and avoiding ones that are deemed to do harm — has a name, and it isn’t ESG. It’s SRI: Socially Responsible Investing. And while it might be easy to confuse the two, they are not the same.
The key difference is that SRI is “is based on exclusionary judgment calls and personal preferences” — meaning the SRI method aims to select or eliminate certain investments due to ethics, not finances. This could mean refusing to invest in companies that, for example, manufacture weapons. Or it could mean giving a pointed focus to alternative energy companies, like solar or wind.
ESG, by contrast, does not exclude nor select based on ethical factors, but instead analyzes environmental, social, and governance factors in tandem with more established financial metrics to seek out potential economic value. Investing in a company that manufactures weapons is not inherently any more risky or potentially profitable than investing in an alternative energy company. And just because a company operates in a “socially good” industry (such as manufacturing environmentally-friendly cars, for example), doesn’t necessarily mean it will score well in an ESG analysis.
ESG is about analyzing risk and opportunity — which behaviors stand to potentially lose, and which ones stand to potentially gain. It is not passing a moral judgment on these behaviors. Instead, it sees higher risk involved with companies that score poorly in its metrics and, conversely, greater opportunity in those that score well.
Why might ESG investing be more sound?
Why are companies that score poorly in ESG metrics considered riskier? Why are ones that score higher considered ripe for opportunity? The reasons are manifold.
One clear answer is that certain companies might face significant public backlash due to these factors, particularly if there is some sort of high-profile accident or disaster, such as the BP Deepwater Horizon oil spill, or a well-publicized scandal such as Volkswagen’s ‘emissionsgate’. Billions of dollars in value could be lost in an instant, harming the portfolios of stockholders who invested in these companies whose risks might have been identified through ESG analysis.
Organizations that score poorly in ESG also run the risk of running afoul of regulators, particularly in stricter areas such as the EU. This, too, could depress their stock price. Notable in all of this is the fact that, while there is no global consensus on environmental issues, many nations — including the two largest in the world, India and China — have pledged to draw down carbon emissions, potentially complicating opportunities for companies that run counter to these nations’ net-zero or carbon-neutral goals.
ESG-centric companies might also provide considerable opportunity due to the fact that they align with certain shifting trends in society. For example, a 2021 McKinsey & Company survey found that a vast majority of employees want their work to be purposeful. Now, “purpose” can be defined in many ways, but it generally suggests a shift toward workers wanting to spend their time at companies that they deem as having a positive impact on the world, and being happier at ones that do. This could be a boon for ESG companies’ performance, as happier employees could be beneficial to stock prices.
And remember: These are just some of the reasons why Sustainable Finance and ESG analysis could be beneficial to investors financially through either preventing considerable losses or possibly opening up doors to new gains.
ESG investing is not about shaping a portfolio for political reasons. It does not exclude companies based on ethics, nor does it choose them for those very same reasons. Politicians might be mislabeling ESG as such in order to play to a base, but experts know the score, and the score, again and again, says ESG is a sound strategy.
ESG, overall, is designed to provide an added layer of analysis, on top of traditional methods, to give investors a cutting-edge approach to finding companies that are best positioned for the future, both in terms of mitigating risk and being well-placed to take advantage of opportunity.
This, it could be said, is at the core of investing itself.
At Rowling & Associates, we are dedicated to acting in your best interests and firmly committed to your financial well-being. Please don’t hesitate to contact us directly if you have any questions about how we integrate ESG analysis to manage your investments. We’ll be happy to walk you through our investment selection process and discuss any concerns you might have regarding your own personal portfolio.