ESG investing is an increasingly trendy topic in the financial industry, and also a political one, with some claiming that it delivers inferior returns. We discuss the finer details with Hallie Kraus, financial planner at the Humphreys Group in San Francisco, a woman-owned and operated wealth management firm and longtime champion of ESG investing.
Light: What is the main goal of ESG investing?
Kraus: Commonly called impact investing, ESG investing—the acronym stands for environmental, social and governance—is based on a desire to make money and do good at the same time. It involves individual investors buying shares of a mutual fund and essentially putting their trust in a number of intermediaries to use their money for good. In exchange, the investment is expected to grow over time.
The concept has gained significant traction, both in terms of capital flow and influence, over the past few years. The shift toward ESG investing is indicative of the changing sentiment among investors and financial institutions toward environmental and social responsibility.
The multifaceted approach to ESG investing seeks to use research, financial support and policy development to increase pressure on the private sector to become more equitable and sustainable. Through this strategy, companies are encouraged to make decisions that are beneficial for society by considering all stakeholders in their decision-making process, including employees, communities and the environment.
Light: What’s behind the ESG acronym?
Kraus: For “e,” the key question is: What does a company do, or not do, to protect the environment? As you’d probably expect, the most important information that falls under this category is a company’s sustainability practices and their greenhouse gas emissions. But this may also include their water and land use practices, treatment of animals, product packaging, renewable energy usage, and whether existing climate change trends will threaten the company’s future.
Then there is the company’s social responsibility: How well does a company treat its employees, customers, suppliers and society at large? Mutual fund companies usually pay attention to labor practices, what sort of hiring, human resources and safety policies the company has adopted, how it protects consumer privacy, customer satisfaction, and where supply chains are sourced.
Finally, there is governance: How do corporate leaders run their business and relate to their stakeholders? Asset managers are usually most interested in executive compensation and how their financial incentives align with the company’s success. They’ll also look at the quality and diversity of the board of directors and management team, how they communicate with shareholders, and examine past lawsuits brought against the company.
Light: What makes ESG investing effective?
Kraus: ESG funds outperform their competitors. Morningstar reported that sustainable funds comfortably outpaced their conventional fund peers in 2019—a pattern that has only accelerated during the pandemic. In 2011, a Harvard Business School study examined 180 U.S. firms and found that those with strong sustainability policies outperformed their competitors by almost 4% per year.
And in 2015, Deutsche Asset Management and Hamburg University conducted the most comprehensive meta-analysis on ESG investing. After reviewing over 2,000 empirical studies since the 1970s, they found that the large majority of them reported a positive relationship between ESG and corporate financial performance. The researchers concluded that the business case for ESG investing is well founded. It’s becoming impossible to ignore that ESG funds are not a risk, they’re an opportunity.
Light: What is the future of ESG investing?
Kraus: ESG Investing is always evolving. It’s good to remember that impact investing exists as a spectrum — a spectrum that has and will continue to evolve as investors respond to the changes within our economy and on our planet. How we make a difference with our money is also sure to change, and we may find ourselves using different approaches on that spectrum to complement our goals and values over time.
If the pandemic year of 2020 taught us anything, it’s that fostering our collective power will get us closer to a more equitable, more sustainable, more empathetic world.
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