Historically, the fiduciary duty of investors was to maximize profits and returns on investments. Until the mid-2000s, any benefit to other stakeholders like employees, the public or special interest groups was secondary.
The decision-making process has since changed with more investors seeking to align their portfolios with their beliefs, putting the maximization of profits either on par with or secondary to this new priority. Environment, Social & Governance (ESG) has also increased in popularity, becoming nearly synonymous with terms like sustainable investing.
Unfortunately, there are key differences in how ESG and sustainable investments are scored, and many investors may find their portfolios are not as aligned with their social and environmental goals as they may have thought.
It’s important to understand ESG is not an investment strategy. Rather, it’s a way for investors to consider metrics that aren’t tied directly to an income statement or balance sheet. ESG is a broad term that doesn’t fully capture a company’s commitment to specific issues and causes.
For example, a company with a high ESG score may be investing a huge amount of time and money in supporting positive environmental goals, like renewable energy, and not much time on fighting social inequality within their workforce. Unfortunately, some companies may not report all relevant information for ESG scoring. This leaves scoring firms to make assumptions, however, many investors find it easy to define exclusionary restrictions and monitor adherence to that policy.
Sustainable investing, on the other hand, is what many investors and managers mean when they refer to an ESG mandate. Sustainable investing is a strategy in which investors believe companies that set and meet sustainable investing metrics may perform best in future periods. These are companies that are investing in sustainable initiatives to enhance their survival and future success. As an example, short-term profit maximization at the expense of labor, the environment or developing governance strategies is not a sustainable strategy and would not be the target of a sustainable investor.
When investors are looking to make a positive environmental impact, it is important to consider ESG scores, understand them, and take those findings to develop a sustainable investment strategy. Investors can do that through a series of mechanisms.
When working with an investment manager, investors should identify the themes and areas they want to invest in. For instance, an investor can express interest in investing in a green energy fund, an ETF (Exchange Traded Fund) whose holdings all have diverse boards of directors or private equity funds that focus on companies that pay employees a fair wage. These themes can be as specific as renewable energy, or broader topics like reduced inequality.
Perhaps the most straightforward and easy-to-implement concept for conscientious investing is simply to screen out the industries an investor may not want to invest in, like firearms, fossil fuels or tobacco. An investor may choose to screen out an industry or company due to high-tier perceptions. This could include not investing in practices that the investor finds run counter to their personal beliefs or personal experiences from interacting with a brand or industry with which the investor has a negative perception or experience. There are no limitations on the number of exclusions an investor can impose on an investment manager.
Impact Investments Investments that target institutions and corporations making a positive impact on society would fall under the impact investment category. An investor focused on impact investments will focus on community development financial institutions or equity investments in companies that promote some area of collective or community good the investor wants as part of his or her portfolio. Large corporations are typically not considered part of the impact universe.
These investment strategies will not necessarily offer the highest returns, although some may. What investors need to understand is these strategies will create deviations from those traditional benchmarks that can either help or detract from relative performance over extended periods. For investors to ensure their investments are making an impact, it will be important to understand how the various metrics and funds work together so they may better tailor their portfolio to align with their goals and values.
Looking ahead, ESG scores and sustainable investing are expected to increase in popularity, especially as investors gain access to more focused and specific information as it relates to an investment’s impact on values and causes that investors believe in. As additional tools and information emerge, it will be natural to assume that ESG-focused investing will only continue to evolve.
Kevin Karpuk is Chief Investment Officer at Cornerstone Advisors Asset Management, LLC. Kevin joined the company in 2000 after graduating from Lehigh University with a B.S. and M.S. in Economics and earned his CFA charter in 2005. Kevin supports many charitable causes and has established a donor-advised fund to propagate his philanthropic interests.