CWG Insight Series: Understanding ESG Investing
Recently we’ve fielded a few questions and concerns from clients around ESG investments in their portfolios and we felt it was a good time to demystify what those investments are and why we use them.
- Environmental, social, and governance factors (ESG) are used to evaluate a company or investment's sustainability.
- ESG investing is a form of sustainable investing that considers environmental, social, and governance factors to judge an investment’s financial returns and its overall impact.
- ESG fund investments return very similar to their non-ESG counterparts but may provide additional upside and more stability in volatile markets.
What is ESG?
Environmental, social, and governance criteria, or ESG, is a framework companies use to evaluate their sustainability. Environmental factors look at the conservation of the natural world, social factors examine how a company treats people both inside and outside the company, and governance factors consider how a company is run.
What is ESG Investing?
ESG investing is a form of sustainable investing that considers environmental, social, and governance factors to judge an investment’s financial returns and its overall impact. An investment’s ESG score measures the sustainability of an investment in those specific categories.
According to the US SIF Foundation’s 2022 Sustainable Investing Overview, in the U.S. there are $8.4 trillion dollars in sustainable investing assets. Nearly all large companies have placed a focus on ESG.
Why invest in ESG?
Aside from having a more sustainable investment portfolio, ESG has other compelling benefits.
Potential for high returns
A 2019 white paper produced by the Morgan Stanley Institute for Sustainable Investing compared the performance of sustainable funds with traditional funds and found that from 2004 to 2018, the total returns of sustainable mutual and exchange-traded funds were similar to those of traditional funds. Other studies have found that ESG investments can outperform conventional ones.
The same Morgan Stanley study found that sustainable funds consistently showed a lower downside risk than traditional funds, regardless of asset class. The study found that during turbulent markets, such as in 2008, 2009, 2015, and 2018, traditional funds had significantly larger downside deviation than sustainable funds, meaning traditional funds had a higher potential for loss.
ESG funds even managed to post strong performance during 2020. Of 26 sustainable index funds analyzed by investment research company Morningstar in April, 24 outperformed comparable traditional funds in the first quarter of 2020 (and the beginning of the COVID-19 pandemic).
How do we invest in ESG?
We are currently using Blackrock’s iShares ESG Aware MSCI USA ETF in our portfolios. This low-cost ETF seeks to track the investment results of an index composed of US companies that have positive ESG characteristics as identified by the index provider while exhibiting risk and return characteristics similar to those of the parent index.
As part of its investment objective, this fund seeks to track an index that applies the following business involvement screens: civilian firearms, controversial weapons, tobacco, thermal coal, and oil sands. The business involvement screens are based on revenue or percentage of revenue thresholds for certain categories and categorical exclusions for others.
The percentage of the portfolio allocated to ESG and the fund used may change from time to time.