Types of ESG Investing Strategies
One of the hottest topics today is sustainable investing, or ESG investing (Economical, Social & Governance). As the purchasing power shifts towards a generation that’s environmentally conscious, socially progressive, and ethically governed, the traditional investing strategies offered by professionals became obsolete. Topics like gender equality, diversity of thought, clean energy, waste management, net-zero economies, executive compensation, and company transparency are now at the fore-front of investing discussions. I became passionate about digging deeper into how companies, investing firms, and investors reacted to this evolution.
We’ll dig into the four different types of ESG-focused investing strategies and how they compare to more traditional strategies.
#1. Broad - Exclusionary
A fund in this category would typically start with a general market benchmark (S&P 500, Russell 1000, FTSE 100, etc.) and remove the bad apples. The removed companies would be based on the products/services they offer (i.e., fossil fuels, alcohol, tobacco, weapons, gambling, etc.). The stricter funds in this category would compare companies within a sector (technology, energy, etc.) and remove the companies with the lowest ESG scores for that sector. I would argue this is the easiest way to “do no harm”, while having a fund that will match the index they are tracking very closely.
However, after analyzing funds that fall into these categories, it’s clear some fund managers have pressures to maintain market performance and may be reluctant to exclude some of the bigger companies that would otherwise be excluded in one of the other ESG categories described below. You’ve got to be very confident to exclude an Apple or an Amazon for their poor environmental and social impact (due to expansive supply chain management, business ethics, anti-competitive practices, among other issues), when they represent 6% and 4% of the S&P 500 index, respectively. As such, I often find it misleading that they refer themselves as “ESG funds”, just because they’ve removed a handful of small- or mid- sized energy companies.
#2. Broad - Strong ESG Practices
A fund in this category typically goes beyond excluding the bad apples, and target companies that have strong ESG scores. These types of funds are still broad in their nature and seem to have similar pressures to maintain market performance. Fund managers tend to focus more on how companies make their products or offer their services, rather than the goods or services they produce.
Keep in mind, ESG stands for Environmental, Social, and Governance. A company can have poor environmental scores, but superior social and governance scores, which makes funds in this category sometimes similar to those in the previous category.
#3. Focused - Impact
We now enter the world of ETFs that have heavy exposures to excellent ESG firms. These funds become much more focused, therefore may look and perform very differently from the average market. Impact ESG funds select companies that actively help solve environmental and societal problems. As you can imagine, few companies meet these criteria, therefore reducing diversification and increasing risk. On the flip side, you can be confident that you are contributing to companies that are making the world a better place, and I believe it’s worth the risk.
For example, iShares MSCI Global Impact ETF (SDG) invests in stocks that generate at least half of their sales from one of the eleven sustainable categories (i.e., alternative energy, sustainable water, pollution prevention, education, sanitation, etc.). Their starting point is the MSCI index, which has nearly 3,000 companies. However, the fund only invests in ~130 of the top impact companies, which illustrates their highly selective process.
#4. Focused - Thematic
Funds that fall into this category are focused on specific ESG issues, therefore tend to have low diversification and higher risk than the other categories. I personally look at these types of funds as sprinkled additions to your portfolio, depending on your personal preferences and beliefs. Some examples of these funds include gender diversity ETFs, global water funds, low carbon energy funds, etc.
Closing Thoughts
Investing is a personal, methodical, sometimes emotional, financial plan to grow your wealth. Many advisers try to strip away the emotions, beliefs, and values that come with investing. At Lybis Investing, we think the complete opposite - How can we achieve your financial goals while investing in our future? If you’re interested in learning more and/or want a sounding board to your investment decisions, visit www.lybisinvesting.com and schedule a free appointment with me.
