What is ESG investing?

ESG investing is the consideration of a company’s environmental, social, and governance practices and impact in the investment decision-making process. 

• Environmental. The “E” in “ESG” looks at the company’s impact on the environment. Things like: energy usage, pollution, resource conservation, the treatment of animals, product packaging, and waste management. It can also include analyses of whether climate change trends will threaten the company’s future.

• Social. Next up, the “S” has to do with the company’s relationship with people: employees, customers, partners, and their communities. It includes the company’s human resource policies, corporate culture, employee engagement, and workforce diversity, as well as customer satisfaction and business practices regarding human rights, child labor, and health and safety.

• Governance. Finally, the “G” deals with the way the company runs its business. From the quality of company and board leadership, board independence, shareholder rights, and executive diversity, to executive compensation, data privacy, and good practices around transparency and disclosure.

Investors (or ESG fund managers) determine whether a company is a worthwhile investment by reviewing the company’s historical financial results and future prospects alongside its ESG rating. 

There are a number of companies who rate and rank companies on ESG factors using percentages, grades, or labels and each uses a different methodology. One of the most often used ESG rating systems comes from MSCI, which labels a company from “good” to “bad” as “Leaders” to “Average” to “Laggards.” There currently isn’t one regulatory body or standard methodology used to determine a company’s ESG rating — and that’s one of the challenges of ESG investing. 

ESG investing benefits

ESG investing is gaining traction among investors, with ESG assets estimated to exceed $50 trillion by 2025. In a number of areas, these dollars are making a difference in how companies operate, who they partner with, and how they produce their goods and offer their services. Overall, we believe that companies that consider ESG impacts in decision making are stronger and more resilient than their peers over the long term, and that can translate into competitive returns for investors. 

• Stripped all the way back, ESG typifies how doing good can often be what’s good for the business over the long term. So much so, the group of financial institutions who created the industry guidelines for incorporating ESG considerations into decision-making went and titled their recommendations, “Who Cares Wins.”

• Companies that strive for higher standards across ESG factors tend to be less risky than their peers. ‌They will be less likely to get hit with financial losses, damage to their reputation, and business disruptions related to ESG issues. (See: BP’s oil spill and Volkswagen's emissions scandal.) This makes ESG investing, like diversifying your portfolio, an engaging strategy to help reduce risk overall.

• What’s more, the research shows that ESG investing doesn’t mean sacrificing returns. It’s (finally) no longer the assumption that social returns and financial returns are mutually exclusive. Recent studies even show ESG strategies achieving higher performance. The reality is that there will always be periods of time where ESG funds outperform non-ESG funds and vice versa. When and how much largely depends upon the strategy’s exposure to specific sectors. For example, if oil prices are up and driving strong performance in oil and gas stocks, an ESG fund with low or no exposure to this sector won’t participate in those gains. Similarly, if oil prices decline, ESG funds that avoid energy stocks will not suffer those losses. But over the long run, we expect the average performance of ESG funds to be on par with that of non-ESG funds. 

ESG investing challenges

One of the biggest challenges in ESG investing is getting high quality, consistent data on all of the ESG factors that may be relevant to a company. Today, there are no industry standards on how ESG metrics are defined or how they are measured. Each company interprets ESG measures in their own way — what diversity means, or low emissions, or pay equity — and then self-reports the results. This means a lack of transparency and consistency across companies, making it hard to do apples to apples comparisons. 

Any company can make claims about certain ESG practices while omitting important details that would show otherwise. This is called greenwashing and it makes it tough for ESG investors to identify which companies are truly achieving ESG goals and standards and which are simply giving lip service. The good news: advocacy for greater transparency and accountability is on the rise. Recently, the SEC has brought actions against investment firms with ESG claims that were not matched with reality. Despite the challenges and complexities of ESG investing, we believe the consideration of how companies manage environmental, social, and governance risk and issues is an important part of the investment decision-making process. It can impact the future resiliency of a company, which in turn will impact its financial performance. When vetted and considered correctly, we believe ESG investing can be a win-win.

How does ESG investing fit in with Ellevest Impact Portfolios?

Here’s why we focus on ESG issues in our Ellevest Impact Portfolios — climate change, unequal pay, and the lack of gender diversity, to name a few examples — all affect women disproportionately. So ESG funds are a big part of our Ellevest Impact Portfolios, because we believe that by investing in companies who follow good ESG practices — and excluding those who don’t — our dollars can help advance women. 

Unsurprisingly, this type of investing is particularly popular among women in investing. And that number will likely grow (here and everywhere) as women’s financial influence surges, considering a third of Gen Z women (33%) and more than a quarter of millennial women (28%) say impact investing is important to them.

By investing in ESG funds, including some focused on companies benefiting women, we’re helping to advance women around the world while offering our clients the opportunity to earn competitive returns. Any investing portfolio you hold with us can be transferred into an Ellevest Impact Portfolio.

Want guidance for making the money moves that align with your goals? Book a complimentary 15-minute call with an Ellevest financial planner or explore our upcoming workshops to learn more about investing for impact.