We live in tumultuous times. Perhaps times have often been tumultuous, but with the internet, social media and endless sources of digital technology available, today’s investor is exposed to a global avalanche of data on the changing world around us. It comes as no surprise then that a growing number of people feel more socially, economically and environmentally educated, and want to make a difference in how they live their lives – and invest their money.
As a self-proclaimed “Millennial” (I sometimes cringe at how the moniker can stereotype anyone between the ages of 23 and 38), my peers and I regularly discuss how we can make informed decisions that help leave our world a better place. We are the recycling, re-using and composting generation, after all, and we are profoundly aware that the choices we make today will have a great impact on the world tomorrow.
Those decisions extend to our budding portfolios – which has contributed to the rise in ESG (Environmental, Social, and Governance) Investing. Though Socially Responsible Investing (SRI) has existed since the 1980s, the term, “ESG” was first coined in 2005 in a report which argued that integrating environmental, social and governance factors in capital markets was a positive step forward in growing sustainable markets.
And grow they have. The late 2010’s have offered retail investors broader access to ESG-oriented funds both in exchange-trade fund (ETF) and mutual fund wrappers. Some ESG funds have even begun to offer exposure to factors like size, value, profitability, and momentum. In 2018 alone, the number of sustainable funds increased by nearly 50%.
In addition to Mutual funds and ETFs, separately managed accounts and private placement providers have further helped the growth of ESG investing, all of which have enabled investors to intricately customize portfolios to better align with their values.
So What Is ESG? – A Refresher
ESG stands for Environmental, Social, and Governance, the three main criteria for socially conscious investors when considering the impact and sustainability of an investment. Environmental criteria might measure a company’s conservation efforts, pollution, and water preservation. Social factors may include worker health and safety, privacy and security, and community involvement. Governance criteria may refer to shareholders’ rights, transparency, ethics, and fraud.
While the Environmental and Social components of ESG are straight forward and aim to fix more easily identifiable issues, Governance tends to be more nuanced, and as McKinsey & Co. define it, “is the internal system of practices, controls, and procedures [a] company adopts in order to govern itself, make effective decisions, comply with the law, and meet the needs of external stakeholders…”.
Governance focuses on specific aspects of a firm such as:
- Executive compensation
- Alignment between the board of a firm and the shareholders
- Ownership and control
- Sound accounting practices
- Equality and diversity
- Labor and safety practices
- Data security measures
Many of these aspects ensure that the firm will operate successfully for the long-term, which benefits shareholders, employees, and customers alike. A famous example of poor governance practices (particularly in the case of accounting practices) is Enron. Fraudulent accounting practices perpetuated by unchecked executives caused the downfall of a once prominent company ultimately harming shareholders and employees.
Governance is increasingly an area that large fund companies like Vanguard, BlackRock’s iShares and Dimensional Fund Advisors, who garner substantial proxy voting power, can utilize to help bring about real change. These firms continuously report their proxy voting results on key issues.
For instance, Dimensional Fund Advisors sustainability funds voted in 2,503 meetings on 25,360 different proposals in 2018 alone on issues ranging from compensation to board elections to mergers. BlackRock’s iShares products had a total of 2,050 different engagements spanning 42 different markets with board composition, effectiveness, and accountability as some of their top priorities.
Thanks in part to the investor stewardship offered by these large asset managers, and the general trend towards ESG, there has been an increase in the overall quality and composition of boards, better long-term alignment between shareholders and executives, fairer compensation arrangements, and higher levels of investment activism to protect and benefit shareholders.
Interested in learning more about ESG?
Regardless of your portfolio size, anyone can participate in ESG investing. Whether you’re already retired, accumulating wealth or just learning about investments, I encourage you to speak with one of our advisors who can help you align your financial goals with your values.
- Morningstar Direct