What Is ESG Investing and Is It Right For Me?
We say yes. If…
Remember the old story about the four blind men who come across an animal and each one touches it in a different place? One touches the tusk, one the trunk, one a leg, and one the side. Each comes to a different conclusion: it’s a spear, a python, a sturdy tree, or a great wall. How they got the elephant to stand still for all this has never been part of the story, but it tells us that our own biases can often obscure the bigger picture.
ESG investing is no different. ESG stands for Environmental, Social and Governance. It is a form of investing that suggests that one can do well by doing good. That’s the elephant. The tusk, trunk, leg, and side are questions like how do I know it works? Who gets to decide what is and isn’t ESG compliant? Is it a fad? And perhaps most importantly, is it right for me? Depending on who you ask, you get different answers.
First, a little history. The precursor to ESG investing is Socially Responsible Investing or SRI. SRI investing as a concept has roots in just about every major religion but was first applied as an investing discipline by the Methodist movement about 200 years ago to avoid companies that manufactured tobacco, weapons, etc. SRI gained traction with institutional investors during the Vietnam War in the 60s and later the South African divestiture movement in the 80s. Shareholders wanted to invest with corporations and money managers who would not support causes they disagreed with. The first SRI fund, the Calvert Social Investment Fund, was introduced in 1982 by Calvert Funds.
The difference between SRI and ESG is that SRI is a morals first equation. It seeks to exclude certain companies or industries. ESG evaluates a company based on its financial performance and how well they incorporate ESG metrics into its operations.
Traditionally SRI managers lagged the broader indices. This makes sense. If you exclude oil and energy, for example, and oil and energy are temporarily driving the broader market, your fund necessarily underperforms. In the past, SRI investors had to answer the question of how much performance I will have to sacrifice to be socially responsible? Often it was quite a bit, so assets into SRI funds lagged.
This is also a highly personal equation. For some, making the most amount of money is the goal. SRI/ESG investing is not right for you. For others, making less money, sometimes a lot less, but sleeping better because you’re doing your part to make the world a better place means SRI investing could be a good fit for you. If you feel the ideal is to align your investments with your values, ESG should be a comfortable fit.
Today, it’s easy to see how ESG investing does versus the broader market. Track an ESG index fund versus the S&P. For example, the difference between CISIX, Calvert Responsible Index Fund, and SPY S&P 500 ETF over the last five years ending yesterday is 61.3% versus 64.2% for SPY, according to Yahoo Finance. In today’s world, you don’t have to sacrifice performance for ethics. iShares and Vanguard also offer passive inexpensive ESG indices.
Active managers like Parnassus, Pimco, Calvert, and Putnam offer funds that choose companies for you based on their interpretation of ESG. We prefer managers like the above who have lengthy experience in this space instead of those who jumped in last year.
Is it a fad? Consider this; 10 yrs ago, only about 15% of companies listed in the S&P 500 index reported ESG metrics in their annual report. Last year that number was north of 85%. When US corporations decide to report and manage their operations per ESG metrics, they are responding to what their clients want. ESG is here to stay.
Topics too big to ignore are usually “the elephant in the corner.” Mainstream pundits may want to pretend ESG investing isn’t real, but when we assemble the facts, it’s real, and the only question is if it's right for your investing style.