Socially responsible investing is quickly gaining traction in the financial and corporate world. Here’s how you can hop aboard the sustainable bandwagon and build a more sustainable portfolio.
When it comes to building your investment portfolio, balancing performance with your personal values as an investor is key to staying the course (and reaching success). Investing in 2022 means we’re not just concerned about portfolio returns, but also what we choose to invest in and how we achieve our returns.
This is why sustainable investing has been gaining momentum as forward-looking investors increasingly strive to align their investments with their personal values and causes they believe strongly in.
ESG investing focuses on companies that meet environmental, social and governance criteria. An ESG investor would thus factor in a company’s take on issues such as climate change, gender equality, diversity and inclusivity, human rights, and whether this is in alignment with how the business is run before deciding whether to invest in it.
So if you’re ready to put your money where your mouth is, here’s a look at ESG investing and how you can build an ESG portfolio to contribute to a better world (while reaping some profits).
What is ESG investing?
ESG investing is a type of sustainable investing that looks at non-financial areas — specifically, environmental, social and governance — to gauge a company’s sustainability, financial returns, and overall impact in those categories.
As an ESG investor, you are helping to influence positive changes in society by putting your money in companies that support the causes you believe in.
If you’re seeking ESG companies to invest in, you’ll want to go for those with the highest scores in those areas determined by independent research groups and companies. A stock screener can help to break down a stock’s ESG scores and reveal a company’s performance in each category.
Here’s a closer look at the three criteria used to evaluate companies for ESG investing.
This looks at the kind of impact a company has on the environment, e.g. the company’s carbon footprint, sustainability efforts in its entire supply chain, chemicals used in its manufacturing processes, etc.
This observes the company’s social impact within the company and in the community, including gender equality, racial diversity across the board, inclusivity, hiring practices and more.
This includes everything from diversity in leadership to executive salary, as well as how well the leadership engages with shareholders and how the company’s management drives positive change.
An ESG-aware investor would pursue opportunities while also managing the risks associated with trends, policies and corporate actions on things like environmental impact, sustainable business practices, diversity, inclusion and equity practices, societal and community contributions, and the demonstration of sound corporate governance.
By considering the factors above, ESG investors should get a more holistic view of the companies they’re investing in, which in turn helps to identify opportunities and mitigate risk.
How has ESG investing evolved over the years?
As sustainable investment strategies become more inclusionary (and significantly accelerated in the 2010s), there are now more investment offerings to keep up with the growing investor demand.
Companies are increasingly investing in new technologies to harness renewable energy to reduce reliance on fossil fuels. Today, China is leading in renewables production and will accelerate its transition away from conventional fuels as it aims to reach peak emissions by 2030 and net-zero emissions by 2060.
The Ukraine war has affected global agricultural yield and led to a fall in key crops (experts predict it will fall as much as 40 percent this year), resulting in higher commodity prices. This has driven importers to diversify their supply sources and look for solutions to maximise yield by relying more on technology and machinery.
Fears of future disruptions also highlight the need for self-sufficiency, resulting in more companies investing in local production, improving agricultural yield, and greater efficiency in terms of food waste reduction and supply chain efficiency.
The importance of cybersecurity in personal, corporate, and even national security continues to grow as people, companies and countries rely more on big data. Add to that the fears of a digital war following the physical war in Ukraine, and stocks linked to cyber security have outperformed the global index this year. It’s thus highly likely that companies will continue to increase spending on cybersecurity.
How can I build and balance an ESG investment portfolio?
To build a good ESG investment portfolio, the key is to identify the impact of a company in the three main areas. Not only will you find meaningful impact in your investment, you can also identify the prospects and sustainability of the company itself.
Identify the causes you support
Ensuring that your investment choices are aligned with your priorities is one way to decide which ESG stocks to invest in.
First, draw up a list of causes you would like to support. If your concern lies more with environmental and social problems, such as climate change or gender and racial inequality, then avoid companies that contribute to or worsen these issues. Pump your funds into the ones that champion these movements instead.
Do your own research
Once you’ve identified the causes you would like to support, do your research by checking out the company’s webpage on corporate social responsibility and decide if the company’s values align with yours.
A good place to start would be news/media outlets that publish ‘best of’ lists of ESG-graded companies every year. From there, you can identify potential companies that might align with your goals. Build a diversified portfolio and choose an asset allocation strategy that fits into your investment timeline. For instance, vary the type of investment areas (renewable energy, cyber security, etc) and asset classes (ETFs, bonds, mutual funds, etc) to mitigate your risk and have a finger in various pies, so to speak.
Be sure to pay attention to expense ratios as well. While ESG characteristics are important, it’s also crucial to take note of more traditional metrics such as cost. Case in point: expense ratios for ESG funds have gone down over the years, but they remain higher than other funds on average—which means you may have to pay a small premium to invest in ESG funds.
Different robos may abide by different guidelines as to what qualifies as an ESG investment, so be sure to understand the various criteria before making a decision. Also take note that robos come with a small fee—which you don’t have to pay if you invested on your own—but if you’re not entirely confident about your judgement when it comes to which investment to make, then you might benefit more from automated investment management and some research of your own.
Turn to financial advisors
A qualified financial advisor can help shape your ESG investing strategies by getting an overview of your financial health and goals. They may also pick up more personalised details that robo-advisors might miss, such as the causes you care about that can be used to tailor an ESG strategy that is aligned with your values.
A financial advisor should be able to guide you towards investments with high ESG ratings that are aligned with your values and investment goals. If you’re working with a financial advisor, ask them what sort of ESG options they’ve recommended to their clients and then research on how well they’re performing.
Even though working with a financial advisor may cost more than independent research or robo-advisors, you’ll get a more intimate relationship with a trusted professional to build an investment portfolio and leave a positive impact on the world.
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