ESG investing is gaining in popularity as investors become more aware of the importance of sustainability in the success of companies over time. Some mutual fund companies and exchange-traded funds have therefore introduced ESG Funds to investors. You can learn everything you need about ESG funds, and decide whether or not to invest.
The Key Takeaways
ESG investment is often confused with socially responsible investments (SRI) and the terms are often used interchangeably.
What are ESG Funds?
ESG stands for Environmental, social, and governance. This acronym is used to identify companies that engage in business practices aligned with the fundamentals for an ESG stock selection.
ESG funds consist of portfolios that include securities and bonds issued by companies who have taken into account environmental, social and government factors when making their investment decisions. Such a portfolio is only open to companies with strong histories and futures in these fields. A fund might not include a company that has a bad track record in this area in its investment portfolio.
Some fund managers focus their attention on companies that they feel have room to improve when it comes to ESG opportunities and risks. A company may be encouraged to align their operations with ESG standards if they are exposed to more ESG risks and opportunities.
ESG funds have a simple rationale. The noble cause of improving sustainability and quality of life is a noble one. ESG is a key factor in investment decisions.
A company may get good press if it decides to keep up with government regulations, for example by installing equipment to clean the air or finding ways of reducing energy consumption. Investors may assume that a company with a responsible approach to risk management is efficient and adheres to sound principles.
ESG funds allow investors to invest in ecological and social issues that will improve the quality of life on our planet while also earning a return.
Why is ESG being pushed?
ESG is controversial on many levels. Investors who are looking to shape a more sustainable future for our planet will look for companies that demonstrate these principles. Many industry names, however, are ideologically against the concept.
Investors have adopted ESG as a concept that has grown exponentially. They see it as an opportunity to encourage companies to adopt green practices, while also making sustainability profitable. Investors should be aware that ESG is still relatively young compared to other investments.
Arguments in favor of ESG
ESG investing has become a popular choice for many investors. This includes individuals and major brokerages. Small investors can feel secure knowing that their money will be going to a company which has responsible operations.
Brokerages can also offer a portfolio that combines smart investing with stocks of companies committed to improving the world. These companies are encouraged to use their financial strength to do as much good as they can by investing in them.
Arguments against ESG are usually based on the fact that it is not defined and there are concerns over "greenwashing".
Some critics say that there should be more standards when using ESG to label companies. They also claim that many businesses use the acronym as a way to attract investors, who will not dig deeper to see if a company is as socially-responsible as the ESG rating suggests.
Conservative critics claim that ESG funds are not focused on maximizing returns for investors, but rather an attempt by funds to appear more "woke." ESG funds have, therefore, inadvertently been dragged into a recent cultural war.
Former vice president Mike Pence, as well as Florida Governor Ron DeSantis, have both publicly opposed ESG investments. Some ESG investors have called the Republican backlash a form climate denial.
ESG is a promising way to combine investing and activism. It addresses many of the global concerns we have about our world, and encourages businesses to build a better future for tomorrow's kids.
There are still questions about the standards of the label and whether or not ratings accurately reflect an organization's ethical values. Sustainability can have different meanings to different people. While a company might believe it is ahead of the game in terms of its commitment to environmental issues, some experts may disagree.
ESG vs. Corporate Social Responsibility vs. Socially responsible Investing
Investors often use ESG interchangeably with socially responsible investments (SRI) and corporate social responsibilities (CSR). There are some minor differences between the three.
ESG investing is a method of investing that considers factors such as environmental, social and governance issues when deciding how to allocate money. SRI can be anything that an investor considers important. It could be environmentalist principles, faith-based values, or support for companies that provide good customer service. CSR is the way a business gives back. CSR includes such things as sustainability programs, involvement in the community, and charitable donations.
You'll often see ESG and SRI being used together. They share many of the same concepts. SRI has been compared to ESG investment by some. SRI is more flexible when it comes to what it takes into account. ESG focuses on specific environmental, governance, and social factors.
How can a company get an ESG rating?
ESG ratings are not assigned by a single entity. Different investment firms, consultants, NGOs and government agencies can all use their own scoring system to rate companies.
The Institutional Shareholder Service, for example, is a service that offers scores and ratings to companies. This includes a rating of carbon risk. Groups can assess a company's sustainability by speaking directly to its employees or reviewing publicly available data.
The group could evaluate a company based on any of the factors listed below:
Allegations of corruption
If groups adopt a more uniform rubric for ESG ratings in the future, this investing practice could become more popular with skeptics. The label may appear inconsistent or arbitrarily based on the fact that there is not a unified SEC "score" of ESG. Why should we trust a company that receives an ESG label from one group, but not another?
ESG Funds Examples
Over 580 ETFs and funds that are sustainable ESG are currently available. Here are the five most popular funds. This is not a recommendation from us. We are giving you names of funds to help you research and understand ESG funds.
Vanguard FTSE Social Index Fund Admiral
Vanguard's VFTAX funds holds Alphabet, Apple, Microsoft and Amazon. The fund is classified as aggressive, and the return tends be volatile. The fund's holdings are still solid despite its aggressive classification.
Vanguard's website states that the fund excludes "stocks of companies that do NOT meet certain labor standards, human rights, environment, and anti-corruption principles as defined by UN Global Compact Principles."
Shelton Green Alpha Fund
Shelton Green Alpha Fund is a fund that focuses on finding green economy companies that have a solid growth potential. It invests in businesses that provide products and services to mitigate economic and environmental systemic risks.
Parnassus Core Equity Fund
The managers of this fund focus on finding companies that are ESG-compliant and exclude those that derive most of their revenues from tobacco, nuclear energy, gambling and alcohol. They use ESG screens to refine their search, and identify companies that have competitive advantages and ethical practice.
iShares Global Clean Energy ETF (ICLN)
iShares ETF ICLN is a good example of how fund manager try to create ESG Funds and maintain them while adhering ESG Principles. The fund's holdings were rebalanced in April 2022 after a change to its methodology. ICLN includes securities from companies that produce solar, wind and other renewable energy sources.
Socially Responsive Balancing Fund (1919) (SSIAX).
The SSIAX Fund of 1919 Fund focuses on high returns from a portfolio that is socially responsible. It looks for undervalued securities, and checks if issuing companies operate in a socially responsible manner. SSIAX aims to have 70% of its assets invested in U.S. stock and 30% in investment grade U.S. bonds.
The Bottom Line
ESG funds include environmental, social and governance factors in their selection process. Investors can invest in companies that have ethical practices. ESG critics are sometimes only arguing with good intentions. It's important to understand that no central organization determines which companies are included in ESG funds.
The individual investor's beliefs on environmental, social and government changes will determine whether they invest in ESG funds. Diversifying your portfolio is not necessary to invest in these funds. These funds are usually invested in by investors to support companies that have a positive impact on the world. Investors who are not interested in these businesses but still want to invest can do so with success.