How to Build a Socially Responsible Portfolio - Farther's Guide to ESG Investing

How to Build a Socially Responsible Portfolio - Farther's Guide to ESG Investing

If you’re looking to establish or change your investing strategy, you might’ve heard the term “ESG investing” by now. In fact, it’s become so popular that, as of the beginning of 2020, one-third of the funds under professional management in the U.S. used a sustainable investing strategy.

If you’re wondering whether ESG investing is right for your financial goals, here’s what you need to know:

What is ESG investing and who is it for?

ESG stands for environmental, social and governance. ESG is an investing strategy that focuses on sustainability and similar value alignment. Here are a few examples of what might fall under each part of “ESG”:

• Environmental: Pollution, climate change, energy consumption, natural resource preservation, waste production
• Social: Human rights, health and safety, LGBTQIA+ rights, employee treatment, community engagement
• Governance: Ethics, transparency and disclosure, executive compensation, shareholder rights
  

If you don’t want to invest in things like oil, guns, tobacco, or companies whose policies or actions don’t align with your values, ESG investing allows you to do just that.

How is ESG investing different from a traditional investment portfolio?

Traditional investment portfolios focus solely on the performance of stocks and mutual funds to inform their strategy. They also tend to go for diversification to help reduce overall risk. But with a traditional strategy, if a particular industry, like natural gas or forestry, starts doing well, that could mean a significant portion of your dollars are invested in these types of companies.

With ESG investing, on the other hand, you start with the values of environmental, social and governance impact and work backwards to create a diverse portfolio that still matches your financial goals. (Many ESG funds are informed by “ESG scores”, which are formulated by third-parties.)  Since those three value areas limit what you can invest in, you don’t have to worry about putting money toward something that falls outside of your core values as an investor.

Pros and Cons of ESG investing

As with anything, there are pro’s and con’s to ESG investing that you should consider:

Pros

You can put your money toward causes you care about

There may be less risk involved than in traditional investing

ESG portfolios have and can outperform traditional portfolios over the long-term

Cons

ESG limits your investing options

You might have trouble finding an advisor who has experience managing ESG investment portfolios

You won’t benefit from returns in industries or companies that don’t fall into the ESG category

Another thing to consider is that ESG investing can prove difficult to implement if you aren't sure about your top priorities.

For example, let’s say you’re trying to decide between two similarly rated tech companies. One has an impact report that showcases environmentally conscious practices, while the other demonstrates a serious commitment to diversity and inclusion initiatives. That could put you in a difficult position if you aren’t sure what to prioritize. (Especially if you don’t have an expert to help guide you through it.)

You’ll have to weigh the pro’s and con’s, and decide if this type of investing strategy is right for you.

What the data says about ESG investing

Aligning your investments with your values is great, but what about returns?

According to the data, ESG investing can be more lucrative than traditional investing strategies. 

A recent Morgan Stanley study, for example, found that U.S. sustainable equity funds outperformed their traditional peer funds by a median total return of 4.3 percentage points. And this was in 2020, during a time of high volatility due to the pandemic and subsequent recession. 

A meta-analysis of over 1,000 studies from the NYU Stern Center for Sustainable Business also found that not only can ESG investment portfolios perform better over longer time horizons, but corporations that focus on sustainability initiatives also tend to perform better (financially) than peers. 

Part of this success could be the fact that ESG portfolios tend to take a tech-heavy approach, and the tech industry tends to outperform the market over long periods of time. This is also true during difficult times, like a pandemic, when technology and innovation are especially important. It can pay to invest in those who can move quickly and adapt to changing times.

While there are no guaranteed returns in investing (whether you’re using an ESG or traditional approach), there is a history behind ESG investing that suggests it’s a solid strategy.

What is the future of ESG investing?

As more and more people look to ESG investing, there are bound to be changes in the landscape, like: 

• More clarity around ESG rating standards
• Increased governmental regulation
• More investing options
• More complex ESG scoring models
  

The number of financial advisors who are familiar with, and manage, ESG investing portfolios, may increase, too. And it will become more important for advisors to have this option available to clients if they want to keep up with demand. But, for those who are interested in ESG investing right now, Farther can help guide you through the process.

Schedule a call with an advisor to start building a portfolio that aligns with your values.