If you keep up with financial media, you have probably read about or heard about ESG investing. It has gained traction over the years and recently been a frequent topic of discussion. But what exactly is ESG investing? It originated from a desire to create socially responsible investment opportunities where investors could restrict certain entities from portfolios like guns, liquor, etc. It has now grown more extensive and gets broken down into categories of Environmental, Social, and Governance. While there are a lot of different criteria and nuances within the categories, they can each be summed up with fairly broad definitions.
Environmental explains how a business performs as a steward of the natural environment. It includes categories of waste, pollution, resource depletion, greenhouse gas emissions, deforestation, and climate change. Social looks at how a company treats their people. In general, social consciousness has become an important aspect of large corporate structures. It includes employee relations, diversity, working conditions, local communities, health and safety of company, and their response to dealing with conflict. Governance explains how a corporation polices itself and how it is governed. This includes tax strategies, executive structures, donations, political lobbying, corruption, bribery, and board diversity.
You may have also read or seen that ESG investing outperforms regular investing. However, there is not enough data to back up that claim. When reporting on ESG, people tend to cherry-pick the data, and make it say what they want it to say. ESG investing simply has not been around long enough to have significant data to compare its performance to regular investing. It also usually comes at a cost with higher expense ratios for the funds than similar indexes. As you can see below, they have similar to less returns YTD, and over the last few years, comparatively.
This is a tough question to definitively quantify at this time, but, yes, ESG funds could be considered a fad. From a performance perspective, the major indexes are more diversified than ESG portfolios. Therefore, it is likely that ESG investing will not perform as well over the long term. However, if you find the idea behind ESG investing compelling, you should probably find an active fund manager, like a traditional mutual fund, that is doing activist type work to make this kind of investing worthwhile. Conscientious investing or socially responsible financial plans can also include giving back to your community through local charities or volunteering opportunities that can make a positive impact as well.
At the end of the day, ESG investing can become very political. And when it comes to indexing, we find it is best if you remove politics from your portfolio. We believe you should instead focus on long term healthy asset classes for diversification through low-cost broad based index funds.
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Matthews Barnett, CFP®, ChFC®, CLU®