Many millennial investors are favoring companies with impactful ESG (environmental, social, and governance) factors, even in the midst of COVID-19.
As Kermit the Frog would say, it’s not easy being green.
Even in the face of increasing reports of climate change, many companies have been reluctant to adjust their business models. After all, developing eco-friendly business practices or products that are more environmentally sustainable can be costly for certain industries.
Still, companies who can pull off going green may appeal more to investors, especially millennials; for the past several years, many investors are prioritizing businesses that have positive ESG (environmental, social, and governance) elements. “ESG investing” is an umbrella term for other socially responsible investing terms, such as “impact investing” and “sustainable investing.”
Investing in ESG companies is increasing in popularity thanks primarily to millennials (people born between 1981 and 1996). According to a 2019 Morgan Stanley report, 95 percent of millennials are interested in impact investing, and 67 percent of millennials have taken part in at least one investment related to ESGs. A 2018 briefing from Fidelity Charitable found that 77 percent of millennials had made an impact investment, compared to 72 percent of Gen Xers and 30 percent of baby boomers.
Even the economic consequences of COVID-19 couldn’t dampen optimism for ESG companies in 2020. Refinitiv, a financial data provider, reported ESG funds saw inflows of $36 billion, and the majority of ESG funds outperformed their technical indicators. Moreover, in the first two quarters of 2020, 74 percent of all proxy proposals brought to U.S. company meetings were ESG-related proposals, according to financial data company FactSet.
As the idea of ESG investing becomes trendier, identifying which companies can be considered ESGs can be tricky. While some companies produce “socially conscious” (if not tone-deaf) advertisements to promote the social importance of their business, other companies specifically market their products or business practices as progressive. However, what one company considers to be ESG-friendly may not match another company’s interpretation.
DEFINING ESG INVESTING
Those looking to add ESG investments to their portfolio should research the product, business model, financial reports, and goals of a company. To understand what those ESG elements are, let’s break down the acronym by letter.
- E (environmental): This can consist of the production methods involving greenhouse gas emissions, energy efficiency, animal welfare, water usage, waste management, pollution, and other climate change risks. Other environmental factors may concern the product itself, such as the ingredients (e.g. committing to using less plastic) or the technology (e.g. electric vehicles rather than traditional gas-powered vehicles).
- S (social): Some examples of socially conscious practices including a commitment to human rights, high labor standards, employee welfare, product safety, and community engagement. A well-known example of this is TOMS Shoes, which initially promised to donate one pair of shoes to children in developing countries for every retail item sold.
- G (corporate governance): The “G” of ESG reflects on both the internal structure of the company as well as its political influence. This may include the board structure and composition, accountability, excessive executive salaries, political contributions, lobbying, diversity, shareholder rights, and financial transparency.
As aspirational as the concept of ESG can be, there are no agreed-upon criteria for identifying those investments. Some investors consider a strategy of negative screening, meaning a company is compliant with ESG standards as long as they don’t have any actively harmful qualities.
On the other hand, some investors focus on a strategy of positive screening, meaning they only choose to invest in companies that meet predetermined standards, such as a certain rate of carbon emission or a dedication to a social charity.
Other ESG investors evaluate the actions of shareholders, board members, and/or executives. For example, some investors adjust their investments based on a company’s donations to political campaigns or controversial charities, such as anti-LGBTQ organizations.
Finally, some ESG investors make decisions based on the company’s goals of engagement. With this lens, investors consider if a company makes a progressive statement, such as a commitment to diversity, and then holds it accountable for following through with its mission.
Some parts of the world, such as the U.K. and the EU, have official regulation for ESG disclosures, the U.S. does not. Therefore, there is no standardization for investors to determine ESG performance and investors often must rely on advertisement from the companies themselves. This has perpetuated a movement called greenwashing, which is a PR spin marketers use to make their companies appear more eco-friendly than they are.
Meanwhile, investors who only support companies that meet the strictest ESG criteria may limit the diversification in their portfolio. Few companies follow the same standards in their business practices, and those who do may have conflicting interpretations of those standards.
Furthermore, organizations that prioritize social or environmental benefits over profits may be a higher financial risk for investors, especially ones with more experimental methods. If a company promises to limit the use of fossil fuels in their production, for example, the initial costs of solar or wind energy infrastructure can be costly and limit the company’s profits.
From the most idealistic investor to the casually conscious, ESG investing can help investors align their financial support with their values. And with many millennials citing it as a main consideration, making ethically responsible investment decisions is becoming more mainstream.