ESG investing — which stands for environmental, social, and corporate governance — gives investors a chance to look at companies from a different viewpoint. Traditionally, a lot of investment decisions were based solely on a company’s financials, but ESG investing looks past the numbers and into a company’s role in society. By no means does ESG investing mean ignoring a company’s financials and conventional investment wisdom, but those aren’t the only factors in ESG investing decisions.
Here’s a quick look at the components of ESG:
The environmental portion of ESG investing focuses on a company’s current role in contributing to environmental problems, as well as its commitment to addressing imminent issues like climate change.
When you examine a company on its social standing, you pay attention to how it interacts with employees, customers, and the outside community, which may not impact its bottom line.
Governance focuses on transparency, compliance, and truthfulness regarding finances and operations.
Here are two reasons you should become an ESG investor and one reason you shouldn’t.
1. You can invest in companies that align with your values
ESG investing allows you to make sure you’re putting your money into companies that align with your values. The main purpose of investing is to make money, but your personal values and financial goals don’t have to be mutually exclusive. Just because a company is committed to operating with high ESG standards doesn’t mean it can’t do so profitably.
If you’re passionate about fighting climate change, for example, you have the chance to invest in companies making strides in renewable energy and green operations. If you’ve been a victim of a data leak, you may feel strongly about customer data privacy and focus on companies in cybersecurity. Whatever the case, you can make sure your money is going toward companies aiming to positively impact things you care about.
2. You can invest in ESG-themed funds
Luckily for investors, more funds are increasingly being put together that are focused on particular themes of ESG investing. With more than 600 ESG funds in the U.S., if you care about an ESG cause, there’s likely a fund specific to it. You can also choose not to focus on issue-specific funds and invest in funds covering all ESG aspects as a whole.
For example, the iShares ESG Aware MSCI USA ETF (NASDAQ: ESGU), the second-largest ESG fund by assets under management, contains mid- and large-cap stocks of U.S. companies that “have positive environmental, social, and governance characteristics,” and has the highest MSCI ESG fund rating possible. If you don’t want to be limited to just the U.S., there are also international funds for you, like the Vanguard ESG International Stock ETF (NYSEMKT: VSGX), which contains companies of all sizes from non-U.S. countries.
Some ESG funds may seem contradictory
One thing that may stick out when you’re looking into ESG funds is that some of the companies the ESG fund invests in don’t seem to fit its objectives. This is generally due to one of two reasons. First, there’s no universal method for selecting companies for ESG funds; some funds consider all three aspects of ESG, some consider two aspects, and some may only consider one. If an ESG fund is considering one aspect and a company fits the criteria while having a bad standing on the other two, it could still be included.
Another reason you may see an apparent contradiction is that although a company may seemingly go against the purpose of an ESG fund by its current operations, its commitment and investments in change may warrant a spot. Take big oil, for example. It’s not far-fetched to see green ESG funds containing significant stakes in big oil companies. Yes, they play a large role in harming the environment right now, but they also make huge investments in green innovation that could change the future.
If your values align strongly around a particular aspect of ESG, be sure to look past the fund’s name and stated mission and into its holdings. You may personally find some funds misleading and decide it goes against your investment objective. More than anything, just make sure you’re aware.