What is ESG Investing?
ESG or environmental, social and (corporate) governance are non-financial factors an investor can use to examine a company’s sustainability performance and build a more socially responsible portfolio. There has been a significant shift towards sustainable investing with sustainable investments now at $4 trillion[1] and increasing actions towards decarbonatization.
Here is a closer look at environmental, social, and governance used to evaluate companies:
Environment: How is the company treating the natural world? This can include activities such as fuel combustion from company activities, water waste, carbon emitted from travel, and electricity purchased.
Social: How does the company treat people inside and outside the company? Social factures can include product safety, human rights, gender issues, equal pay, workers treatment, and community support.
Governance: How does the company’s management make these changes? This includes diversity within the board of directors, executive compensation, protecting shareholders’ interests and corruption and bribery.
ESG in Recent Years
Recently, investors have shown interest in creating a more sustainable future. ESG investing can create a sense of fulfillment to an investor and allow them to invest in what they believe in. For instance, 50% of all investors and 75% of millennial investors were moved to invest more sustainably in response to social justice movements. Additionally, the COVID-19 pandemic may have changed society’s values and prompted investors to invest in ESG funds. According to Morningstar Direct, U.S. sustainable funds saw a record inflow of $10.5 billion in the first quarter of 2020. By December 2021, U.S. sustainable fund assets grew to $357 billion. that global ESG assets are expected to reach $53 trillion by 2025, representing more than a third of the $140.5 trillion in projected total assets under management.
ESG investing is considered the way of the future. Larry Fink noted that “our investment conviction is that sustainability- and climate- integrated portfolios can provide better risk-adjusted returns to investors. And with the impact of sustainability on investment returns increasing, we believe that sustainable investing is the strongest foundation for client portfolios going forward.” Asset management groups and the upcoming generation are welcoming this new wave of investing.
Possible Drawbacks & Government Regulation
Cash inflow to ESG funds has increased and ESG funds have performed exceptionally well in spite of recent market volatility yet this does not guarantee future success or success across the board. For instance, 2022 has been kind to ESG funds in the energy sector but technology stocks have taken a fall. Moreover, ESG investing can limit portfolio diversity because most ESG friendly companies are large-cap stocks. Focusing on a single industry like electric vehicles or entirely excluding industries like oil can lead to a
This practice is referred to as “greenwashing.” For example, companies such as Volkswagen have claimed to be “green” but in actuality violated government environmental regulations.
As of May 2022, the SEC has released an that seeks to amend the rules and forms under the Investment Advisers Act of 1940 and the Investment Company Act of 1940 to oversee enhanced disclosure of ESG factors. Currently, a uniform set of ESG criteria does not exist, making it difficult to compare and contrast company profiles. Sites such as S&P Global, Refinitiv, Bloomberg Terminal, and MSCI offer ESG company reports but vary in criteria. The SEC proposal seeks to solve these inconsistencies by creating a framework of disclosures that is consistent, comparable and decision useful, allowing investors and advisory services to make better informed choices.
Conclusion
The future generations seem to be moving towards a more sustainable and socially upright future through ESG investing. Investors can make conscious efforts to prevent corporate grievances, improve the environment, and protect human rights. However, investors can only do so much. Companies have made slow progress with improving their ESG issues because it is . When the government requires specific disclosure requirements, companies will be forced to make a change and ESG investors will have an even greater influence in the market.
This blog is available for informational purposes only and does not, and is not intended to, constitute legal advice on any subject matter. By viewing this blog, the reader understands there is no attorney-client relationship established between the reader and Wilson Bradshaw LLP. Readers are urged to consult legal counsel regarding any specific legal questions about a specific situation.
[1] Larry Fink’s 2020 Letter to CEOs: The Power of Capitalism; Sources: Morningstar, Simfund, Broadridge. Data includes Sustainable Mutual Fund, ETF, Institutional and Alternative AUM, as defined by third party data sources, excluding integration/engagement flags. MF and ETF data as of Oct ’21, Institutional & Alternatives data as of Jun ’21.
