Earth Day ESG

As Earth Day 2021 approaches, it’s a good time to think about Environmental, Social, and Governance (ESG) investing. The concept gained momentum in the 1980’s, after the global movement to divest from companies doing business in South Africa, which was still operating under the segregationist regime of apartheid. At many universities, including my alma mater, student demonstrations were instrumental in the decision by endowments to divest from all companies doing business in South Africa.

The South Africa disinvestment effort helped provide more enthusiasm for a nascent part of the investment world called Socially Responsible Investing (SRI). SRI/ESG attempts to help investors understand whether publicly traded companies adhere to specific guidelines around environmental, social, and governance issues. During the bull market of the 1980’s and 1990’s, there was just a smattering of mutual funds that screened out the companies and industries that did not meet particular value criteria, like energy, tobacco, and exposure to South Africa.

In the early days, being a socially responsible investor was hard to execute. Some funds often threw together different screens, which effectively left you with a portfolio that had too much of one sector, leading to a lack of overall diversification. Additionally, it was difficult to discern which companies were doing business in ways that might not align with an investor’s values, because the companies were not reporting their activities in a uniform way that could allow a proper screening of what businesses might raise a red flag.

That changed in 1999, when United Nations Secretary-General Kofi Annan introduced the concept of a Global Compact at the World Economic Forum in Davos, Switzerland. The compact asked business leaders to join in an effort to share “values and principles, which will give a human face to the global market.”  As companies embraced the Global Compact, they started to report their results in their shareholder communications.

The adoption of the compact effectively meant investors could rely on a data set through which they could determine whether a company had stated climate change policies and how well the company adhered to those delineated policies. A sub-industry of ESG research was born, which led to the ability of investors to rely on concrete numbers and metrics that demonstrate real progress. The data have helped bolster the argument for ESG investing.

Armed with information, money poured into sustainable investing, and the past few years has seen the biggest jump. The US SIF Foundation's 2020 biennial Report on US Sustainable and Impact Investing Trends, released in November, found that sustainable investing assets now account for $17.1 trillion, or 1 in 3 dollars, of the total U.S. assets under professional management. This represents a 42 percent increase over 2018, when the amount stood at $12 trillion, and shows exponential growth since 1995, when sustainable assets only made up $639 billion!

The investment is paying off: According to a report by McKinsey “A strong ESG proposition correlates with higher equity returns” and it “also corresponds with a reduction in downside risk.” The mitigation of risk jibes with a recent study by the Morgan Stanley Institute for Sustainable Investing, which found ESG funds have fared well amid the current market volatility and also on a longer-term basis. From 2004 to 2018, “sustainable funds experienced 20 percent less downside risk compared with traditional funds.”

Doubters still abound. Venture capitalist Chamath Palihapitiya, who made his fortunes as an early employee at Facebook, called ESG investing a “complete fraud,” and “a lot of sizzle, no steak,” when he appeared on CNBC in February 2020. Economist Burton Malkiel, who wrote the legendary Wall Street book, “A Random Walk Down Wall Street,” had a more nuanced argument against ESG Investing later in the year.

Malkiel takes issue with how companies are rated and worries that those who are analyzing ESG issues “can’t even agree on how to evaluate these companies.” An analysis from Barclay’s Bank found that “measuring a fund's ESG focus is everything but straightforward. There is a lack of consensus on how many and what aspects of E, S and G should be assessed in each relevant dimension, and as a result, different providers score ESG-related criterion differently.”

Another issue is that while a company can score well on the environment, what if it does not do so well on governance? As a whole, that firm may have a so-so grade, which means that as an investor, you may not end up with the kind of company you really want in your investment portfolio. Barclays advises investors “to do far more due diligence to ensure that their investments do indeed align with their objectives.” Who has the time, energy or expertise for that?

The good news is that a collective hunger for ESG investing has driven even a myriad of investment companies to create more options. Morningstar created a list of inexpensive funds here, which is a good guide. The funds are divvied up into active vs. passive, as well as the size of the company, and U.S. vs. global.

However, because many Americans invest through their work-based retirement plans, you may be faced with fewer choices. While many employer-based retirement plans include options for ESG investing, the vast majority has not yet added them. Your best bet is to get a group of like-minded employees and ask your benefits department to include at least one ESG choice to the mix.