What is ESG Investing and Why is it Important?
ESG, which stands for Environmental, Social, and Governance, is a method of investing that overlays key metrics around social responsibility into the investment decision-making process. These metrics that are tracked by internal accounting statements, NGOs, governments, non-profits, and other organizations are used to avoid or underweight the ownership of companies and bonds that may be exposed to ESG-related risks. The belief is that changing consumer trends, stricter government regulation, and innovative technologies will put legacy assets with negative ESG scores at risk, thus producing lower returns. We can see an example of this with the fast growth of car companies that embrace EV technology while car companies that fail to develop battery technology lag behind in the market. So, the answer to what is ESG investing and why is it important can also be described as attempting to overweight future opportunities while underweighting environmental, social, and governance-related risks—things not readily apparent on an accounting statement. There is also an argument that consumer trends will drive returns toward favorable ESG-ranked companies. It is shown that 88% of consumers are more likely to be loyal to a company that supports social or environmental issues[1].
The history of socially responsible investing spans over 100 years, making it a long-standing concept. However, it is still commonly believed that ESG is a new investment management style. In the United States, the history of socially responsible investing started from religious beliefs opposing the slave trade in the 18th century. Early Methodists and Quakers in the U.S. banned their members, organizations, and businesses from investing or operating in anything directly or tangentially involved in the slave trade as well as alcohol, tobacco, and gambling[2]. From the 18th century up until the 1960s, socially responsible investing was largely driven by religious organizations avoiding the “sin” industries as they saw them. This exclusionary tactic, backed by religious and moral principles, formed the groundwork for what would become a similar ethical based stance in the 1960s and 70s. As opposition to America’s involvement in Vietnam grew, University endowments began divestment in defense contractors as a stance against war. A similar tactic occurred during the Apartheid controversy in South Africa. Capital divestment on the basis of a moral or ethical standard has been a part of the investment process since the very beginning in America.
How we think of ESG investing today has changed since the early days of religious-based divestment. We look at ESG funds that not only avoid problematic industries with troubled assets but also invest in projects that improve communities and our planet while seeking better returns. We can trace this type of ESG investing back to the Domini Index fund created in 1990. This was the first formal index that attempted to track the best-performing companies from an ESG lens, at the time called “socially responsible investing.” Today we know of this index as the MSCI KLD 400 Social Index Works, and it primarily holds large, U.S. tech-oriented companies due to their relatively low carbon footprint. This index reveals a common concern with the ESG investing space. It is more concentrated than a market-neutral approach and tends to lean into tech and growth businesses, reducing diversification.
However, from a scope and operational perspective, the ESG landscape has changed drastically in the last few years. We have seen the emergence of more robust legislation around reporting, better data tools to reveal ESG metrics within companies, and more low-cost funds that compete with core offerings. These innovations and changes are challenging the stereotype that ESG investing is niche, subjective, or high cost. There are now ESG-screened funds from authentic legacy socially responsible investment companies that compete in cost to low-fee providers like Vanguard, Fidelity, and BlackRock[3]. Not only can you get a low-cost, diversified fund, but it comes from a company that operates as genuinely as their funds, something a Vanguard or BlackRock cannot say.
At Longwave, we take our fundamental, academic-based approach to portfolio management with 100 years of research and apply that to the fast-growing and innovative technique of ESG investing. We are unique in our methodology and we believe that gives us an advantage. It is shown that the largest hurdle to widespread ESG investing adoption is not from investors but from wealth managers, and we are here to buck that trend, leading the way with a thoughtful, science-based approach. Our team has been involved in the ESG investing space since its formal inception which gives us a deep knowledge of the space. This experience helps us separate the wheat from the chaff, avoiding all the new greenwashed funds that are moving into the space as a cash grab. We partner with fund companies that operate as responsibly as the fund solutions they provide. We believe in taking ESG from an exclusionary indexed approach to impact, making meaningful changes in our communities, business practices, and environmental stewardship. Your capital is your strongest vote, and we can help guide your capital toward impact while meeting your financial demands. Values-based investing has been around for hundreds of years and is here to stay.
[1] 2017 Cone Communications CSR Study: https://www.cbd.int/doc/case-studies/inc/cs-inc-cone-communications-en.pdf
[2] Preqin Historical Timeline of ESG Investing: https://www.preqin.com/preqin-academy/lesson-5-esg/history-of-esg
[3] Calvert ETFs: https://www.calvert.com/etfs.php
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted. Actual results may vary.
Investing involves risk, including the risk of loss. Investment risk exists with equity, fixed-income, and alternative investments. There is no assurance that any investment will meet its performance objectives or that losses will be avoided. ESG investing approaches may perform differently compared to investments that do not have such an approach or compared to the market as a whole. The application of ESG-related considerations may affect exposure to certain issuers, industries, sectors, style factors or other characteristics and may impact the relative performance of the investment strategy – positively or negatively – depending on the relative performance of such investments.