ESG investing means something different to just about everyone. While all can agree that the acronym stands for Environmental, Social, and Governance, beyond that it starts to get hazy. There are mountains of data, hundreds if not thousands of academic pieces, and a seemingly infinite number of opinions on the topic. We are not here to settle any debates or draw definitive conclusions, but we would like to illustrate how we approach ESG investing.
One of the most debated points in this topic area is whether it is better to exclude companies from the portfolio if they do not adhere to or espouse one’s ESG principles (known as a “negative” screening), or to channel assets only to the leaders in these areas (“positive” screening). Another approach is to invest and take an active role to influence the companies’ policies and practices.
Still another version is known as “Impact Investing,” whereby we may not just seek to identify generically “good” or “bad” companies but invest in projects that are exclusively focused on a specific positive outcome. An example of this is Apple’s issuance of $1BN worth of “green bonds” to fund construction of wind and solar projects to power their facilities. All of these approaches have merit, for sure, and it is impossible to choose whether one way is superior to another on behalf of another values‐oriented investor.
Another component for consideration is whether or how to weigh one of the ESG factors over another. For example, what if a company is lauded for its environmental record, but does not do well in governance areas such as gender or racial diversity? In this scenario, an investor taking the very popular “Fossil Fuel Free” approach would likely not want the same holdings as one whose primary interest is to see more female directors and officers at their portfolio companies.
Once you include all the variables, and consider that the “E,” the “S,” and the “G” have dozens of individual sub‐categories each, you can see there are as many combinations and iterations of approaches to ESG investing as there are opinions among investors.
To make matters more difficult, a significant challenge for any ESG investor is how, and how stringently, to perform the required due diligence. One only need to consider the Volkswagen emissions scandal froma few years ago as an example. On the surface, VW looked like the darling of the auto industry for environment‐minded investors (not to mention car buyers!) based on their emissions scores, but then it was disclosed that they cheated on the tests.
The depth and breadth of the scandal is enough to generate concern that similar “greenwashing” may be happening in more places and going unnoticed. How, then, is a Main Street investor supposed to have the access and knowledge to foil such a devious plan by the likes of Volkswagen?
Another factor to consider is how investors can effectively implement their ESG views in constructing their portfolios. While there are several flavors of ESG‐specific mutual funds and ETFs, it has been our experience that they fall short in meeting the specific needs and requirements of each individual investor. While a separately managed account is an option for some, the minimums can be too high for other individual investors.
Similarly, most of the available fund and ETF choices focus on the large cap sector of the US market; implementing ESG goals across an entire portfolio can be quite difficult. Finally, one of the main reasons to invest is to earn a rate of return that meets your overall goals and objectives. From a performance perspective, studies have very different outcomes as to whether ESG portfolios deliver a better or worse outcome vs. non‐ESG portfolios.
To be sure, we do not think we should throw our hands up on ESG simply because it is difficult. On the contrary, we believe it is important not to rely on the self‐reported virtues of Earth’s corporate citizens, but instead to partner with firms whose sole mission is to hold these companies to a higher standard on behalf of interested investors. Specifically, this is why we use professionally‐managed mutual funds by companies with established track‐records and the seal of approval from investors who believe that “doing well by doing good” is more than just a catch phrase.
For many of the reasons cited above, our approach is not to try to create a separate flavor ESG portfolio for every palate, but rather build portfolios that satisfy investors with a broader approach. For investors wanting a custom‐tailored portfolio according to their own specific values, let’s discuss what that might look like.
The above article was written by Mario Nardone, CFA, of East Bay Financial Services, a registered investment advisory firm that serves as an outside investment consultant to Four Ponds Financial Planning LLC.