ESG investing enables investors to participate as stewards of the planet and its inhabitants by leveraging environmental, social, and governance factors when they invest. The primary goal of the ESG investment is profit, but the impact must benefit beneficiaries for it to be tagged as an ESG investment. ESG investments have been growing in popularity year over year, as investors desire to make a difference as they invest:
"A record $649 billion poured into ESG-focused funds worldwide through Nov. 30, up from the $542 billion and $285 billion that flowed into these funds in 2020 and 2019, respectively, the latest Refinitiv Lipper data shows. ESG funds now account for 10% of worldwide fund assets." – Analysis: How 2021 became the year of ESG investing, Reuters.
The concepts behind ESG investing are significant as they challenge corporate behavior and capitalism in our society. Changing demographics, shareholder expectations, consumer preferences, and regulatory pressures motivate and amplify Environmental, Social, and Governance (ESG) influences concerning the vulnerable ecosystem we depend on. How much of an impact ESG investing has will determine the future winners and losers of the business represented and the investment itself.
ESG investing comes from the same principles as socially responsible investing. Still, ESG screening takes it one step further by selecting measurable ESG factors of each company represented in the fund before the fund can be tagged as ESG:
Environmental- Conservation of the natural world
- Conservation of the natural world
- Climate change and carbon emissions
- Air and water pollution
- Biodiversity
- Deforestation
- Energy efficiency
- Waste management
- Water scarcity
Social- Consideration of people and relationships
- Customer satisfaction
- Data protection and privacy
- Gender and diversity
- Employee engagement
- Community relations
- Human rights
- Labor standards
Governance- Standards for running a company
- Board composition
- Audit committee structure
- Bribery and corruption
- Executive compensation
- Lobbying
- Political contributions
- Whistleblower schemes
In February 2022, Morningstar removed the ESG tag from more than 1200 funds in their classification system, roughly one in five, over concerns that ESG asset managers were making false claims their fund was doing the planet and its inhabitants good. ESG funds have due diligence requirements beyond just adhering to what can be statistically measured or screened. As fiduciaries, they must act in the best interest of their beneficiaries, but also investors who desire to do good through ESG investing.
The good news is that Morningstar’s correction signals future examination within their system if it appears the ESG fund is using ambiguous language or green-washing through the ESG label. If ESG funds themselves don’t meet the requirements above, they may lose the confidence of the wealth management industry and investors. The companies represented in the ESG fund must also practice what they preach regarding their behavior.
Work with a financial professional
If you have a desire to do good through ESG investing, your financial professional can help determine which ESG funds are operating as a fiduciary and if the companies represented in the fund are scoring high in all ESG standards.
Important Disclosures
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
Socially Responsible Investing (SRI) / Environmental Social Governance (ESG) investing has certain risks based on the fact that the criteria excludes securities of certain issuers for non-financial reasons and, therefore, investors may forgo some market opportunities and the universe of investments available will be smaller.
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
This article was prepared by Fresh Finance.
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