Updated: Aug 26, 2021
Provided by Robert Warther, Warther Private Wealth
ESG stands for Environmental, Social and Governance factors, which are used to rate companies with the help of traditional financial metrics. In recent years, this practice has gained a lot of interest, especially among younger investors. MSCI has determined three of the most common motivations for incorporating ESG into your portfolio.
Long Term Results
The first and most simple motivation is that investors believe incorporating ESG into their portfolios can improve their long-term results. Companies that have strong ESG practices are known as “ESG Leaders” while companies who do not may be labeled a “ESG Laggard”. An example of an ESG Leader could be a company that promotes diversity and inclusion and offers good benefits to their employees, while an ESG Laggard could be a company who has a history of labor strikes or a high employee turnover rate.
MSCI supported this conclusion by comparing 13 year returns of the MSCI ACWI Index and the MSCI ACWI ESG Leaders index. The ESG Leaders index aims for companies that have the highest ESG rated performance in each sector compared to its standard counterpart in the regular ACWI index. Although the ESG Leaders index has fewer companies in it, it outperformed the regular index by 7.9% over 13 years.
ESG investing also allows investors to align their financial decisions with their personal values much easier. Through the use of negative screening each investor can identify and exclude companies that are involved in specific ESG issues they are against. A good example of negative screening is apparent when looking at the differences between the MSCI World Index and the MSCI WORLD ESG Screened Index. The screened index contains 88 fewer companies than the regular index. It excludes any companies who are associated with weapons, tobacco, fossil fuels and any company not in compliance with the UN Global Compact. The UN Global Compact is a corporate sustainability initiative that focuses on issues such as corruption and human rights. This is a great example of how investors could match their moral values to their financial decisions.
ESG investing is also a great tool for investors who want to make a positive impact with their investments. Sometimes called impact investing, investors can align their investments with companies that are making positive change they want to see. For example, an investor could invest in a negatively screened index or equity, or purchase green bonds, which are used to fund environmental projects.
Future of ESG Investing
ESG investing appeals to a wide range of investors. A 2019 survey conducted by MSCI determined that 84% of U.S. investors want the ability to match their values with their investments. The survey also found that 86% of them believe that companies with strong ESG practices may be more profitable. These results support the high demand that U.S. investors have for ESG investing. Since 2018, ESG related assets in the U.S. have grown from 12 trillion, to 17 trillion, which is a 42% increase. ESG related assets now account for 33% of total U.S. assets under management!
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