3 Things You Need to Know About ESG Investing

Over the past twenty years, there has been a slow but steady trend emerging among financial services:

An ESG investing approach where investors seek long-term competitive returns while simultaneously creating positive societal impact.

Being a “socially responsible” investor in previous years meant avoiding investments in companies whose products or services were “unethical.” This includes companies that produced alcohol or tobacco, advocated gambling, manufactured weapons or burned fossil fuels and harmed the environment. Continuing with this trend, investment managers now proactively screen for a wide range of ESG factors for potential long-term advantages. According to a new survey by BNP Paribas, nearly 80 percent of institutional investors incorporate ESG factors into their decision-making. Therefore, “socially responsible” investors increasingly seek opportunities that contribute positively to society to generate sustainable and financial value.

This approach also received a major vote of confidence in October 2015. The Department of Labor issued a bulletin that allowed private sector employers to add ESG fund options to retirement plans. Consequently, this ruling led to an explosion of funds offering such strategies. U.S. assets invested in ESG strategies grew from $6.57 trillion at the start of 2014 to $8.72 trillion at the start of 2016 – an increase of 33 percent.

Given this spike in interest and demand, here’s what investors need to know about ESG investing today:

ESG investing’s primary benefit:

Investors aim to achieve positive impact through corporate engagement or an emphasis on community, sustainability or the advancement of women. Therefore, ESG investing means different things to different people. However, a common thread is investors using a portion of their investments to provide future portfolio growth and to support issues, causes and practices that may lead to a better society.

The risk and limitations:

Many managers incorporate ESG criteria into their investment selections to build portfolios that reflect an impact strategy. While different approaches appeal to different investors, such strategic initiatives include:

Positive ESG investing: Here managers invest in a diversified portfolio – with sectors or companies selected for positive ESG performance – relative to industry peers. This approach usually includes avoiding companies or sectors that do not meet certain ESG performance targets. With this option, investors choose a fully diversified portfolio approach for their overall investment strategy. The portfolio does not involve measurably more risk than other fully diversified funds.

Impact investing : Here managers use ESG criteria to build focused portfolios, with targeted investments aimed at solving social or environmental problems. The investment funds are more focused and may carry more risk. Choices might include funds that select companies promoting women on boards, or those focusing solely on alternative and clean energy. These will reflect an investors’ personal passions and should be integrated into portfolios by reviewing the specific investment risk of the fund. The rest of the portfolio investments should balance this specific risk.

Sustainability investing : Here managers use ESG criteria to select investments specifically related to global sustainability. This approach is a hybrid of the two above. Many of these funds will be fully diversified and fit easily into a total portfolio allocation. Others might emphasize areas that bring a higher level of specific risk that needs to be balanced by other investments.

The future of ESG investing:

More investors are understanding that the ways we spend and invest can influence the fabric and consciousness of society. Even millennials are looking for ways to achieve their social impact goals. As society embraces ESG investing, it has the potential to become mainstream and an essential part of investor portfolios.

All in all, ESG investing has a bright future among investors. There are several seasoned approaches to implementing this into portfolios – as a core part of an overall portfolio or a specifically focused allocation.