ESG Investing: Align Your Portfolio with Your Values

The past few years have shone a spotlight on an investing approach that digs deeper into investors’ priorities than just financial returns. Many people are now asking how they might use their investment portfolios to address issues like climate change, social unrest and diversity/inclusion. We believe that’s why investing with an environmental, social and governance (ESG) focus has been moving to the forefront.

ESG investing has become a tool that allows investors to align their principles and values with their investments. This investing approach considers factors such as each company’s environmental footprint, brand reputation, participation in social causes and inclusive corporate governance practices. With this information, investors can more carefully choose which businesses to include in their portfolios.

A company’s financial performance will likely be a key factor for investors who are conducting their due diligence. We believe it’s important to know that ESG-related factors may also impact a company’s long-term outcomes. Many public companies now understand the importance of sustainable investing and are shifting their behaviors to become better all-around corporate citizens.

As a result, investors who also care about ESG issues may benefit—both financially and in terms of their personal values—from these broader measurement tools.

What do E, S and G represent?

E = Environmental

This category considers the impact that companies have on their surroundings and natural environment. Does the company track its water usage, carbon footprint and use of clean technology, for example? These factors can help quantify the company’s environmental impact, and positive trends in these categories may lead to beneficial outcomes.

For example, product packaging is an area where waste has been rising, especially with the growing popularity of e-commerce and delivery of products. Dell is one company that has disclosed using recyclable packaging made of bamboo—and it has one of the highest recycling rates in the software sector.1 Actions like these not only help to reduce negative impact on the environment but also have the potential to channel capital to the most sustainable companies, while trying to reward both the investor and the environmentally friendly business.

S = Social

This category includes a company’s impact on social good and positive social change. A corporation’s involvement in (and stances on) issues such as human rights, diversity, employee health and safety, and community engagement may be considered.

A company with a positive social impact “score” (as calculated by a recognized ESG-rating provider) may see an increase in trust among employees and shareholders. These factors may improve the company’s stability and boost its share price in the long run.

G = Governance

Governance issues refer to how well and how diversely a company is managed. The positive governance category could include management quality and education, equitable executive compensation and diversity, as well as corporate transparency regarding its disclosures.

You may have seen in the news that Volkswagen Group provided an example of poor governance. In 2015, it was revealed that the company had programmed 11 million diesel vehicles to cheat emissions tests.2 The company suffered billions of dollars in penalties and a sharp blow to its reputation.3 Could this issue have been avoided with an ethical management team?

From our experience, it seems that companies that demonstrate they have quality leadership teams and are constantly improving their governance methods would earn a positive rating on the “G” portion of an ESG scale.

Do I sacrifice anything being an ESG investor?

When it comes to ESG investing, many portfolio managers proactively seek out companies that have done well in all three major categories. They may use several reputable databases to determine each company’s overall ESG rating. The good news is that investors may not have to sacrifice potential financial returns because, in our experience, portfolio managers look for companies that include positive ESG factors rather than try to exclude firms that rate poorly on ESG factors.

Socially responsible investing (SRI), which was a forerunner to ESG investing, focused on excluding industries or companies that were involved in business activities perceived as damaging or irresponsible. For example, an SRI strategy may have entirely excluded stocks in the energy sector because of public perception that oil and gas companies were bad for the environment.

An ESG strategy, by contrast, might thoughtfully consider how companies are helping improve the environment through their operations. For example, an oil and gas company that commits resources to clean-energy technologies and reduces carbon emissions could be included in an ESG portfolio. An investment manager’s strategy could include selecting more stocks and bonds from companies that rate well on environmental factors and reducing (or bypassing) stocks and bonds from firms that have low environmental scores.

Overall, an ESG approach may help investors allocate capital to companies that align with their personal values, but still allow them to remain diversified in their investment choices and provide long-term upside potential.

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