ESG stands for “environmental, social, and governance.” This type of investing falls under the “sustainable investing” category. These investments aim for good returns and positive impacts on society, the environment, and the business. For many decades, most investors focused on the Freidman Doctrine, which teaches that companies only have one responsibility to shareholders: make them as much money as possible. However, it’s become clear that caring only about profit results in often destructive decisions and negative consequences. Many investors now want the stocks they hold to align with their ethical values. Let’s break down what that looks like:
The “E” in ESG stocks refers to how a company impacts the environment in both positive and negative ways. Environmental issues include climate change policies, greenhouse gas emissions, carbon footprint, water-related concerns, recycling, and renewable energies. Investors can also consider the relationship the company has with environmental regulatory bodies. You can get an idea of practices and initiatives from a company website, but you’ll get a better picture from reports that use standards like the Global Reporting Initiative.
The social part of ESG is about how the company affects people. That includes a company’s employees, consumers, suppliers, and society at large. To learn more about how a company treats its employees, look at employee benefits, pay, staff turnover, training, and diversity and inclusion practices. “Social” also includes ethics within the supply chain, customer service, and public stance on social justice issues. You can find information on many of these topics on a company’s website and reports that use The Global Reporting Initiative, which includes social issues as well as environmental ones. You’ll often hear about how a company treats employees and values people through the media and websites like Glassdoor.
“Governance” has to do with things like company oversight and the board of directors. ESG investors care about how the business is run and if corporate incentives match up with the company’s successes. Topics include executive compensation and bonuses, diversity within the management team and board, transparency with shareholders, and the relationship with regulatory bodies. Every year, most companies hold a meeting where shareholders vote on issues like executive compensation, proposals, and director appointments.
Examples of ESG stocks
Using the guidelines for environmental, social, and governance topics above, you can search for stocks. There are many ESG funds, as well, so you don’t have to take a long time searching for individual stocks. According to many experts, Microsoft is one of the most famous examples of an ESG stock because of its history of philanthropy and environmental initiatives. Nvidia, a technology company that designs graphics processing units, is part of the MSCI World ESG Leaders Index, the Dow Jones Sustainability Index, and the Bloomberg Gender Equality Index. NextEra Energy, the world’s largest producer of wind and solar energy, also meets all the standards of an ESG stock.
Risks of investing in ESG stocks
Investing in stocks always comes with risks. One of the most significant risks with ESG investments is that there aren’t as many standards compared to traditional investments. What makes a company “socially responsible” is not set in stone, and many businesses are still figuring out how to measure their success in areas like their carbon footprint, company diversity, and so on. The other major question is how well do ESG stocks even perform? You’ll find contradictory information about how returns compare to traditional stocks. With time, more data will come in, but if you’re concerned mostly about returns right now, ESG could be risky.
Should you get into ESG stocks?
Investing in ESG stocks is becoming increasingly popular as people seek to align their investments with their values. Many are no longer only concerned with high returns. They want to play a part in making the world a better place, as well. Millennials are especially interested in ESG stocks. Research shows that this demographic is more likely to trust a company if it has a reputation for being environmentally or socially responsible. This encourages more companies to change their practices. More tracking data and standards measure their success, so businesses that are all talk and no action will face consequences.
What about returns? There is some evidence that ESG stocks and traditional stocks perform similarly. Some studies even show that ESG can do better. There’s also a chance that ESG stocks come with less risk. In a Morgan Stanley study that looked at the markets in 2008, 2009, 2015, and 2018, traditional funds came with a higher chance of loss than sustainable funds. With the potential for high returns and less risk, ESG stocks are clearly not a fad. They’re here to stay.