Increasingly, many investors have been choosing to put money where their values are — into a growing array of products that fall broadly into the category of environmental, social and governance investing, often called ESG investing for short.
If you’re thinking about investing in ESG products, here are some tips to keep in mind and traps to avoid.
ESG investing strategies use a variety of environmental, social, and governance criteria to make investment selections that aim to create both competitive financial return and a positive impact on society.
On the environmental front, you might find investments that focus on clean energy technology, water conservation, or other environmental issues.
Socially responsible investment criteria might include factors such as gender equality, workplace diversity, fair labor standards, safe working conditions, and human rights.
On the governance side, factors such as executive compensation, board diversity, or anti-bribery and corruption policies might weigh into investment decision making.
There is no formal definition of an ESG investing style, and various names are often used interchangeably to describe it, such as “sustainable investing,” “socially responsible investing,” and “impact investing.”
ESG investments are available to retail investors primarily through mutual funds, but investments such as exchange-traded funds (ETFs) and green bonds also offer ESG investment options. In addition, employer-sponsored plans and robo-advice platforms might offer sustainable investing choices.
The key takeaway: Each ESG investment is unique, and should be evaluated on its own terms.
If you’re considering an ESG investment, or own ESG investments already, keep these tips top of mind.
- Know your investment goals and risk tolerance. Any ESG investment should mesh with your overall investment goals. And because all investments carry some degree of risk, you will want to be knowledgeable about, and comfortable with, business and market risks associated with your investment.
- Understand the ESG fund’s investment criteria. This information is found in the fund’s prospectus. For example, some funds use an exclusionary investment process when making investment choices (for instance, omitting stocks of companies that are in particular sectors such as tobacco or alcohol). Others use an inclusive process (for instance, including companies that meet certain ESG criteria such as those focused on long-term supply chain sustainability or that maintain a minimum percentage of female board members). Some funds focus on a range of ESG areas, others might focus only on one aspect, such as governance.
- Be alert to potential “green washing.” Calling an investment “green” can be subjective, which opens the door to the potential exploitation of the label. Due diligence, including a close reading of the fund prospectus or bond offering, is a good place to start your investigation. Track any environmental milestones the various companies in a fund or bond issuer might report. Use your own judgement to decide whether an investment meets your criteria for a green investment. For instance, would you consider a bond to build a dam “green” if the underlying project included the installation of a wind farm? Reasonable minds can differ. Sometimes, the only person who can answer such questions is you.