3 things you need to know about ESG investing before you get started
For a while, the amount of money a company brought in was the deciding factor in deciding if someone wanted to invest.
However, the popularity of ESG investing (which stands for environmental, social and corporate governance) has steadily increased over the years. ESG investing looks at companies from a different perspective, allowing investors to look beyond financials. This doesn’t mean completely ignoring finance and other traditional investment wisdom, but it does mean incorporating ESG standards into your investment decisions.
Here are three things to know if you’re interested in ESG investing.
1. What aspects of a business are rated
The three metrics on which companies are rated are environmental, social and governance. The environmental part deals not only with the current impact of the companies’ operations on the environment, but also with their commitment to greener operations and the reversal of global problems, such as climate change. This is especially true for companies that process fossil fuels and use large amounts of energy.
Socially, companies are rated on how they interact with customers, employees, and the wider community. Whether it’s diversity (or lack thereof), employee safety, customer data privacy, or philanthropic efforts, as an investor you should want to know where companies stand on these Questions. Not only are they presenting problems now, but they will likely present more in the future, such as poor employee retention or a lack of top talent.
When reviewing a company’s governance position, you want to ensure that it is compliant, truthful in financial reporting, and transparent. You never want to go into an investment without knowing where the companies stand on these issues, as this could prove costly for investors. Lack of transparency or compliance can lead to misinformation, which often leads to misguided investments. As an investor, and therefore a co-owner, you don’t want to be left out of the operations of a business.
2. How the MSCI Rating System Works
There is no universal ESG rating system, but the MSCI ESG score is widely used to evaluate companies. The MSCI ESG ratings are:
Companies rated CCC to B are considered laggard and more exposed to ESG risk factors. Companies in the BB, BBB or A range are average; some aspects are well managed, while others may be poorly managed. If a company manages to achieve an AA or AAA rating, it is considered an ESG leader, managing ESG risks better than its peers. Less than a quarter of companies manage to be labeled as leaders, so it’s a coveted title to receive.
3. Some investors may find ESG funds misleading
A source of concern for many investors interested in ESG funds is the tongue-in-cheek nature of some of the companies within these funds. While the objective and purpose of a fund may mean one thing, the companies within it may apparently run counter to that purpose. This is partly because there can be vague definitions of what counts as ESG investing and what aspects of it are considered. Some funds may focus on all three aspects of ESG, while others may only focus on one or two.
It is not uncommon to see green bottoms containing Big Oil. Take the iShares ESG Aware MSCI United States ETF and SPDR S&P 500 ESG ETFs, for example. These ESG funds hold companies like Marathon Oil and ExxonMobil, respectively. Big oil companies play a huge role in pollution simply by the nature of their operations, but they also make some of the biggest investments in green innovation, putting some investors between a rock and a hard place.
If you care about a particular aspect of ESG and don’t want to be misled by its holdings, you should look beyond the name of the fund and what it claims to represent and focus on that. who is actually in the bottom.