With the urgent need to tackle climate change, more attention is paid to the impacts of companies on the environment and the communities they operate. A 2023 report published by the Intergovernmental Panel on Climate Change — the United Nations scientific arm on climate change — notes that greenhouse gas emissions need to be cut by almost half by 2030. This reduction needs to happen in all sectors so global temperatures increase no more than 1.5 degrees Celsius when compared to pre-industrial levels, a goal that requires private and public entities to make changes in their operations and investments.
For everyday people, ESG investing, also referred to as sustainable or socially responsible investing, provides an avenue to invest their money in companies that make better environmental and social decisions. This often includes taking steps to reduce their carbon emissions. In the last decade, and particularly, in the past four years, more people have become interested in these investments.
“When I started working with sustainable investing in the 1990s, the way that people did socially responsible investing was using negative screens to avoid owning the types of companies that they didn’t want to own in their investment portfolio,” said William M. Reilly, senior vice president and senior financial advisor at Merrill Lynch Wealth Management.
“Now through technological advancements and better reporting, what’s more common is what is considered ESG investing, that not only avoids the types of companies that people don’t want to own, but actually identifies companies that are making good decisions in those areas.”
While the terms sustainable investing and ESG investing are often used interchangeably, investment firm Edward Jones differentiates between the two. Sustainable investing is an all-encompassing term for financial investments that take into consideration people’s values. Within this umbrella are investors who exclude specific types of companies they consider “negative actors” from their investment portfolios, for example, fossil fuel companies or gun manufacturing companies, commonly referred to as values-based investing.
ESG investing, as its acronym denotes, considers a company’s environmental, social and governance performance. This information is monitored and self-reported by companies.
“What ESG investing typically does is incentivize companies to make good decisions,” Reilly said. He added that because companies have to report information like their environmental risks, carbon footprint, the way they treat their employees and the diversity of their board, they tend to make more responsible decisions.
This information is paired with traditional financial measures so investment managers can evaluate the company’s risks and opportunities and align them to their clients’ financial goals.
“We rely on them to provide data through their annual reports, but a good active manager in that space is going to do their own research and assign their own risk factors to certain companies,” said Joe O’Krepky, financial advisor at Edward Jones.
This additional layer of active management is important as the demand for ESG investing has increased and continues to increase. Bloomberg projects that by 2025, global ESG assets will exceed $53 trillion. Knowledgeable financial advisors are key, as companies can provide misleading information suggesting they are more environmentally responsible than they really are, a term known as greenwashing.
Financial research shows that ESG investments offer benefits to investors, such as diversifying their portfolio and reducing risks. “If you invest in companies who have good scores in environmental, social and corporate governance metrics, those companies tend to have higher earnings, they tend to have higher dividend yields, their stock tends to perform better on a 12-month basis [and] they’re less likely to go bankrupt,” Reilly said.
ESG investing also provides a mechanism for people to encourage companies to have a better performance.
“To me, ESG is always about being an active investor and having a voice in that boardroom,” O’Krepky said, adding qualified and committed financial advisors are key to help investors have a voice in the companies they own.
“And if the company that you’re investing with isn’t carrying your voice to them, then they’re not the right manager for you.”
“Shareholder activism is when owners of companies, owners of stocks, owners of mutual funds take action to address the company and make them act better,” Reilly said. “So, we help our client be good shareholders and help the companies that they invest in make better decisions and become better.”