E.S.G. Investing - What it Means and Its Pros/Cons

this video is sponsored by squarespace go to squarespace. com the plain bagel to save 10 off your first purchase of a website or domain using code the plain bagel ethics and investing are probably two words you don't often find together from scandals to pollution greedy executives to blatant rights violations corporations have carried out many environmental and social harms over the years in the name of profits it's something that leaves investors in a tough predicament on the one hand we often need investing to fuel our wealth and help us accomplish our financial objectives like retirement but on the other investing can enable these organizations to carry out wrongdoings now investing in general doesn't have to involve selling your soul to the corporate devil but recently we've seen the rise of esg investing an approach that considers not only the financial gain of a position but also the direct and indirect effects the business has on the well-being of others it's a really cool strategy that has gained meaningful ground but as life would have it even this form of ethical investing has its shortcomings and while it's important to put your money into companies you can truly stand behind relying just on the esg label can leave you paying higher costs while still investing in companies you wish to avoid so let's explore the definitely not controversial topic of ethical investing on today's episode of the plain bagel traditional financial models have long focused almost exclusively on monetary factors if a project was expected to make money it was a go even if it caused a greater cost to others because of this regulations have been introduced over time to ensure that corporations who had a tendency to focus exclusively on profitability operated in a way that aligned with the interests of other stakeholders from minimum wages to pollution restrictions these regulations have come to be fairly broad in their scope but while these rules can prevent blatantly harmful actions there are many gray areas that regulations simply don't address and as generations have become more aware educated and active on social and environmental issues investors have started taking it upon themselves to support only those companies that align with their own values this approach goes by many names ethical socially responsible sustainable investing but it is often broadly referred to as esg investing which stands for environmental social and governance in the world of stocks these are the factors considered when trying to determine the ethics of a firm's operations environmental considerations include pollution and animal welfare social factors include human rights employee compensation and community engagement in corporate governance refers to diversity and how a company manages those at the top esg investing involves analyzing these three considerations and incorporating the findings into standard financial models so that how a firm is run is considered alongside its profitability and while there's no standardized approach to the practice there are two broad strategies that are used negative screening and positive screening negative screening involves removing companies from the universe of stocks to be invested in based on certain traits the investor is looking to avoid tobacco firearms and gambling are all areas that frequently get the boot with this strategy other times the approach involves removing companies with certain red flags like those with a history of human rights violations or companies that have committed fraud positive screening on the other hand is more proactive and looks to invest in companies that are actively benefiting or supporting positive initiatives while operating their business this includes renewable or green investing where investors put their money behind wind solar and other sustainable energy companies as well as investing in companies with more equal opportunity employment practices and diverse management teams once the universe of stocks has been narrowed down an esg fund may look to score their holdings based on the esg factors enabling them to identify which companies are doing their part and which ones are doing the bare minimum how an investor or fund weighs these factors against the traditional financial analysis can vary some funds will simply carry out traditional financial analysis and put more of their money in the stocks with higher esg scores other funds will use the esg factors as the primary determinant to their investment decisions regardless the approach looks to better balance traditional financial models with the ethics of the holdings themselves now esg investing isn't the only approach to ethical investing there are other methods that are worth mentioning here impact investing for example looks for investments to not just produce financial return but to achieve some explicit positive outcome while community investments seek to fund underserved communities to help them better develop while these approaches certainly have social value they do put more weight on the social and environmental outcome than the financial benefit to the individual and as a result they tend to be higher risk with many facing the real possibility of becoming a mere donation that's not to say there's no value in these areas but when managing our finances our goal should be to ensure we're taken care of and while bill gates wasted drinking water machine is a really cool innovation that could really help out a lot of people it doesn't make for a great retirement investment for your average joe so for many esg offers a better balance providing investors a chance of reaching their financial objectives while still supporting their values it's a practice that's become very popular over time in fact the amount of money in sustainable mutual funds is estimated to have grown from under 500 billion dollars in 2013 to 750 billion in 2018 with the amount forecasted to reach 1. 8 trillion dollars by 2028.

the rise in popularity has also led many companies to be more proactive on their esg front blackrock the largest asset manager in the world recently released a letter highlighting that esg factors should be the new standard for investors while simultaneously releasing a number of esg products companies like nike have also been more active on making donations and standing behind social causes and as the social spotlight turns on corporations many have promised to change their ways in favor of more socially responsible strategies as an investor it's an encouraging thing to see i mean who doesn't want to do good and make money in the process but while esg investing certainly has its merits there are some important shortcomings that you need to be aware of before you go buying any esg funds for one esg investing is not a standardized approach and you may find that an esg fund doesn't actually align with your own values just like the field of ethics itself where different schools of thought provide different answers to the same important ethical questions investment firms use varying criteria for analyzing esg factors and there's no standard that dictates how lenient a fund can be on certain issues for example there are many esg funds that hold fossil fuel companies and while this is obviously a debated area that i'm not going to take a side on an environmentalist may be surprised to find a fossil fuel company in their esg fund even if it is the most efficient operator in their space on top of this while there are rating companies that provide esg scores that people can reference scores for the same company can vary drastically between different rating agencies showing just how little agreement there actually is on certain issues esg factors can also actually be fairly difficult to analyze there are a lot of details to consider including a company's operations their supply chains their employees their partners so on and so forth and in the u. s companies aren't actually required to track their esg performance which means we're often forced to make our decisions based on the self-advertised information put forth by the firm not only does this make finding red flags difficult but we've seen many companies greenwash their operations where they take on minor initiatives or provide false promises to give the impression of some larger ethical operation finally while there are clearly social benefits there are some financial shortcomings to the investor when it comes to esg investing strict esg criteria can greatly limit the diversification of your portfolio an investor who only wants to invest in renewable zero waste positions will have a much smaller pool of stocks to choose from than other investors and we'll be heavily exposed to the unique risks of those companies and sadly there is a cost to esg because esg funds and high-ranking esg stocks garner a lot of demand they can actually be more expensive esg funds tend to charge a higher fee than traditional funds while highly visible ethical companies tend to trade at a higher multiple than peers meaning you need to pay more for the same profitability than you would with a standard stock these cons are what make a seemingly easy decision between ethical and traditional investing a bit trickier it can certainly be discouraging to think that those trying to be good people have to pay more now some investors might believe the benefits are certainly worth the cons and the costs and even with my superior judgement i'm not here to tell you the right approach to esg investing but even if you think esg funds are a scam i should highlight that investors can still benefit from investing ethically in considering esg factors themselves companies with proactive social and environmental policies usually face lower regulatory and legal risks regulations tend to become more strict over time so a company that's proactive in its policies is less likely to face a lawsuit or need to make a major change we've also seen customers become more active in supporting and blacklisting companies based on their values which makes it more important for companies to be run ethically it's why a lot of investment companies even those that aren't explicitly running esg funds consider these ethical factors when making investment decisions believing them to be a good indicator of the risks faced by a firm finally some research actually suggests that certain progressive strategies including having a more diverse leader base actually improves the stock's performance although it is unclear whether being progressive improves profitability or if being profitable simply enables companies to be more progressive regardless there's something to be said for considering esg factors even if you stick to traditional investment approaches and if you invest in stocks yourself there are some ways that you can look to ensure your holdings align with your own values most companies will list in their regulatory filings the societal and environmental impacts of their operations as well as the initiatives they have in that area and you'll typically find an esg section in their annual reports so you can screen companies based on issues you care about when it comes to governance you can broadly gauge a company by looking into the committees they have set up to govern management as these groups tend to be the independent guidance for management as well as the company's history of lawsuits employee pay so on and so forth if you don't have the time or expertise to invest in individual companies yourself it's easy enough to find mutual funds and etfs with these buzzwords of esg and sustainable in their name but if you're going to take on the costs that may come with this approach it's worth taking the time to go through the fund's prospectus to determine what criteria the fund manager is using to screen their investments ensuring that this approach aligns with your own expectations at the end of the day ethical investing is surprisingly a highly debated topic in investments some professionals believe the job of an advisor is only to earn their client the best return possible something that may require putting money in companies with poor social optics others believe that investors have the power and duty to support companies that will have a positive impact on the world needless to say there are many gray areas where even the most ethical of investors disagree are fossil fuels immoral if the area is necessary for economies and transportation as they currently exist is amazon a tyrant if it enabled many consumers to continue shopping for necessities through a pandemic is a.