Traditional Investing Vs. ESG Investing
With all of its recent growth, ESG investing can seem like an entirely different concept compared to normal investing. However, they are not actually that different from one another.
The most popular form of ESG investing is through ESG funds, which are essentially just mutual funds that incorporate ESG principles. The purpose of adhering to these principles is that conceptually, investors will be investing in companies that are likely to have a sustainable and societal impact in the world. Because ESG funds are so similar to mutual funds, they also share many of the benefits. ESG funds are a collection of multiple stocks grouped together, which is beneficial because it decreases the risk since the investment is spread out among so many different companies. If one company in the fund goes out of business, all the other stocks in the fund and mitigate the loss.
Another form of ESG investing is ESG ETFs. Just like ESG funds, it works exactly like a normal ETF except ESG principles are considered. ETF stands for exchange-traded fund, and the main difference from mutual funds is that they can be traded throughout the day similar to stocks. The main incentive to engage in ESG investing is that it is generally seen to have a lower downside risk than traditional funds. While ESG investing has been a fairly new concept to the market, the performance of ESG funds and ETFs have been sufficient enough to support this notion.
It is striking how similar ESG funds and ETFs are to traditional investing, but how does the process on how to choose ESG funds differ? The first step is to determine whether to invest in an active, or passively managed fund. Actively managed funds actively try to beat the stock market performance and offer a higher return, but also a higher risk. Passively managed funds grow much slower, but are generally much cheaper, and are more dependable to perform better in the long run.
The second step is to determine where to have an impact. Many companies have certain areas of ESG where they are more focused on, so investors should look to invest in ESG funds that best align with their own values. However, it is also important to look out for greenwashing, where a company makes false sustainability promises to obtain an ESG label to investors. The third consideration is an investor’s current investments. Investors want their portfolio to be diversified because it reduces risk, and gives the greatest chance of high returns. It is a good practice for investors to see how the ESG fund would fit into their portfolio. Lastly is to examine the actual impact of the investment. The best way to do so is to view a company’s impact report, which reports data such as shareholder engagement, gender diversity among the workforce, or the company’s carbon footprint.
When investors follow all of these steps, they can increase the likelihood that all the benefits associated with ESG will be carried out and maximized, and ultimately can seamlessly integrate ESG funds into their portfolio.