Learn How to Invest in ESG with Our Beginner's Guide

A lot of investors are getting curious about how to put their money into environmental, social, and governance (ESG) funds and stocks because of rising climate worries and social issues. ESG investing is all about making a positive impact with your cash by backing companies that are committed to bettering the environment, promoting social justice, and practicing good governance. If you're looking to grow your wealth while making the world a fairer place, getting a grip on ESG investing is key. You'll want to learn how to invest in ESG, from setting up a brokerage account to checking out ESG investments. This article will dive into various ESG investments and strategies to help you match your money with your values.

A Definition of ESG

ESG stands for environmental, social, and governance criteria, which is a way for companies to assess their sustainability. Environmental factors focus on protecting the planet, social factors look at how companies treat people, and governance factors check how a company is managed. Here are some things each ESG category includes:

Environmental

• Water usage
• Waste management
• Green energy efforts
• Deforestation
• Air and water pollution
• Carbon emissions

Social

• Human rights issues at home and abroad
• Company policies on sexual harassment
• Customer satisfaction
• Data security
• Employee gender and diversity

Governance

• Lobbying
• Internal corruption
• Major lawsuits
• Executive salaries
• Political donations
• Diversity on the board

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Working of ESG Investments

Let’s break down the three criteria for evaluating companies in ESG investing:

• Environment: What kind of impact does a company have on the environment? This includes things like the company's carbon footprint, how it handles toxic chemicals in its processes, and its sustainability efforts throughout its supply chain.
• Social: How does the company make a positive social impact, both within its walls and in the wider community? This looks at everything from LGBTQ+ rights to racial diversity in leadership and hiring practices, plus how the company advocates for social good beyond its own business.
• Governance: How do the board and management of the company push for positive change? Governance covers everything from executive pay to leadership diversity and how well that leadership engages with shareholders.

CSR vs. SRI vs. ESG

Another term you might hear is socially responsible investing, or SRI. While both SRI and ESG aim to create responsible investment portfolios, there are some differences. ESG is a way to measure a company's sustainability in those three areas: environmental, social, and governance. On the other hand, socially responsible investing, ethical investing, sustainable investing, and impact investing are broader terms. Often, “socially responsible investments” are assessed using an ESG grading system. 

In the past, different sustainable investing methods varied in how they built their portfolios. For instance, SRI used an exclusion-only method to filter out investments seen as immoral, like tobacco or alcohol. ESG investing also excludes those investments but adds companies that are making a positive impact. 

As the world of sustainable investing has expanded, those terms (and others) have started to blend together. You might find providers offering a “socially responsible” portfolio that includes ESG funds (rather than just avoiding certain investments), and others with the same label that only use an exclusionary approach. So, it’s important to check out how a portfolio is put together, no matter what it’s called. 

CSR, or corporate social responsibility, is a practice companies adopt to better their local communities, the environment, or society in general. Besides helping their causes, CSR initiatives can boost a company's reputation. Those planning CSR initiatives might take ESG factors into account when designing their strategy.

ESG Investing Benefits

First off, it helps you build a more sustainable investment portfolio, but there’s more to it. 

You get lower risk, too. A study by Morgan Stanley showed that sustainable funds usually have less downside risk compared to traditional funds, no matter the asset class. During rough market times like 2008, 2009, 2015, and 2018, traditional funds faced way more potential losses than sustainable ones. Plus, in 2020, sustainable index funds did really well, with 24 out of 26 funds outperforming their traditional counterparts in the first quarter.

Then there’s the potential for high returns. A white paper from Morgan Stanley looked at sustainable funds versus traditional ones and found that from 2004 to 2018, their total returns were pretty similar. Other studies have also shown that ESG investments can actually do better than conventional ones. JUST Capital ranks companies on things like fair wages and environmental protection, and its JUST U.S. Large Cap Diversified Index (JULCD) has returned 15.94% annually, beating the Russell 1000’s 14.76% return.

Types of Investments in ESG

When it comes to types of ESG investments, there are a few popular ones worth checking out.

ESG Mutual Funds

These can quickly diversify your portfolio. The number of these funds has grown a lot recently, going from 270 in 2018 to 303 in 2019, according to Morningstar. Some focus on specific issues like green energy, making it easy to tailor your portfolio. If your broker has a mutual fund screening tool, you can compare funds based on their ESG ratings. To get more info about a specific fund, like which companies it invests in, be sure to check out its prospectus, which is usually on your broker’s website. This document will also tell you about the fund’s expense ratio, which is the annual fee you pay as a percentage of your investment. You can use a mutual fund calculator to figure out what that would look like for a specific fund.

ESG Stocks

As for these, it’s generally wise to avoid putting too much of your portfolio into one or a few individual stocks. But if you really dig a particular company and believe it’ll do well over time, buying its stock could be worth it. Some companies provide impact reports that showcase their sustainable efforts and how they tackle issues like carbon emissions. To see how a company rates for its work environment, check out a site like Glassdoor. Don’t forget to look at traditional factors like revenue and net income, too. 

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Real-World ESG Investments

If you’re looking for examples of ESG investing, there are various ways to do it, like investing in an ESG fund or a stock with a high ESG score. Here are some examples of top ESG funds:

• iShares MSCI USA ESG Select ETF (SUSA)
• Parnassus Core Equity Investor (PRBLX)
• Thornburg Better World International I (TBWIX)
• Pax Large Cap Fund Institutional (PXLIX)
• 1919 Socially Responsive Balanced A (SSIAX)

Steps to Start Investments in ESG

Getting into ESG investing doesn't have to be a hassle. With tons of ESG options available now, you can easily start building your portfolio. Here’s a casual guide on how to get rolling with ESG investing.

1. Decide if you want to go solo or get some help

If you're thinking about creating an ESG investment portfolio, you’ll need to think about whether you want to pick the investments yourself or use a robo-advisor to handle it for you.

A. If you want some help with ESG investing

Creating an investment portfolio can take a bit of time, especially when you’re looking for options that match the ESG vibe. Robo-advisors can simplify this process. These digital advisors help you build and manage your investment portfolio based on your risk level and goals, usually at a lower cost than traditional advisors. Plus, many robo-advisors are now offering sustainable portfolios without extra fees to automate your investing. Here are a few that focus on socially responsible investing:

• Merrill Edge Guided Investing: You can invest in an ESG portfolio and set limits on certain ETFs.
• Wealthfront: They have a ready-made socially responsible portfolio, and you can tweak it with socially responsible ETFs.
• Betterment: Offers three types of impact portfolios: Broad Impact, Climate Impact, and Social Impact.

Just make sure to check a robo-advisor’s approach to see if they use both inclusionary and exclusionary filters, if that’s something you care about. If you go with a robo-advisor, you can skip the next steps.

B. If you want to find your own ESG investments

If you’re up for diving into a company’s sustainability efforts or ensuring a fund’s values match yours, you might want to build your own ESG portfolio. If you still need a brokerage account, here’s how to set one up. Some brokerages even have screening tools that can help you sort through different ESG (or sustainable/socially responsible/ethical) investments. Once you have your brokerage account, you can move on to the next step.

2. Figure out your own ESG criteria

ESG has some clear guidelines, especially compared to “ethical investing” or “socially responsible investing,” but it might not completely align with your personal beliefs. Everyone has different values, so take some time to pinpoint what matters most to you, and see if any of those values go beyond the typical ESG framework. If they do, make sure to look for investments that reflect those beliefs. For example, Muslim investors might want to ensure their investments comply with Islamic law.

3. Pick your ESG investments

After setting up your brokerage account and deciding which industries you want to support, you can start building your portfolio. Checking reviews from independent research firms like Morningstar can help you see how a company or fund measures up on ESG factors and whether you want to invest in them. When creating your own ESG portfolio, you’ll probably want to include things like ESG mutual funds, exchange-traded funds, or ESG stocks.

How ESG Scores are Determined

An ESG score is a measurable way to rank a company based on various environmental, social, and governance issues. Different organizations calculate and try to standardize these scores. They’re based on info from things like securities filings, corporate disclosures, government databases, academic studies, and media reports. Generally, screeners give companies and funds an ESG score between one and five. 

When looking for ESG investments, choose your preferred ESG score. Scores can differ by industry and reporting agency, so treat them as just one piece of the puzzle when making investment decisions.

Conclusion

ESG funds have become super popular lately. They’re a solid way to encourage sustainability in businesses. But before you pick an investment based on its sustainability criteria, make sure it’s a good fit for your investment goals. ESG isn’t a guaranteed way to outperform a bad manager or hold back a good one. Always check the fundamentals of any fund you’re thinking about buying.

This content was created by AI