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Zacks Advantage Blog

3 Things to Understand About ESG Funds

November 20th, 2020 | Posted in Investing, technology

3 Key Insights About “ESG” Investing

Many readers may have heard of a new trend in financial markets known as “ESG” investing, which stands for Environmental, Social, and Governance. The term first appeared in the investment lexicon in 2004, and MSCI defines it as the “consideration of environmental, social and governance factors alongside financial factors in the investment decision-making process.”

For obvious reasons, ESG investing has high appeal in the current environment. According to a recent survey conducted by Morgan Stanley, 84% of millennials place emphasis on the importance of ESG ‘impact,’ and this is a demographic poised to substantially increase participation in the financial markets. According to a recent study, millennials are poised to inherit some $68 trillion from their parent’s estates by 2030, which may find its way into the capital markets.1

The ESG category is feeling tailwinds – total assets invested reportedly grew from $47.33 billion in September 2019 to $82 billion by the end of May 2020. But before you consider making a significant investment in the ESG category, there are a few insights you should take into consideration.

Insight #1: ESG Investing is Only Related to Clean Energy

Many investors new to the ESG category may think the ESG investments are only related to ‘clean,’ renewable energy. While many ESG-focused funds and ETFs will indeed invest heavily in renewable energy companies, there are other social and governance categories that are also included. For instance, a fund that excludes companies involved in the sale of tobacco, alcohol, or gambling may qualify as ESG because of its focus on social-responsibility criteria.2

When investing in an ESG fund or ETF, it is important to examine how companies are chosen for the fund, and what criteria is set for inclusion.

Insight #2: ESG Investments Do Better – Or Worse – Than Conventional Investments

There are hundreds of research studies examining returns of ESG investments versus conventional ETF or equity funds. Some studies find that ESG has outperformed since inception – others find the opposite. It really depends on the fund and what is being used as a benchmark.

The bottom line is that we may not have enough data available to draw statistically significant conclusions from comparing ESG investments to conventional equity investments. One thing investors should keep in mind, however, are potential fees associated with ESG investments – which may ultimately detract from returns. Generally speaking, socially-responsible ETFs assume a higher cost of researching and vetting companies for inclusion into the fund, which may be passed along to the investor in the form of higher fees. As we all know, higher fees can detract from total return, particularly over a long stretch of time.

Insight #3: ESG Investing is the Best Approach for Aligning Values with Investing

Many people want to align their personal values with their investment choices, which is admirable and increasingly popular. Perhaps that just means not investing in companies that make guns or facilitate gambling. Or maybe you do not want to have any exposure to oil and gas companies. A customized portfolio can afford you these possibilities.

But there may be other ways to align your values with your investment decisions. For one, by choosing not to own tobacco or gambling or oil and gas stocks, those companies can simply go out and sell stock to conventional investors or funds, such the impact of excluding them may be more personal than fundamental. By owning those companies, however, an investor may be able to take a more active approach to having their values heard – by speaking up at general meetings for shareholders, filing shareholder resolutions and complaints with regulators, or giving statements to the media.

Additionally, an investor might consider taking the approach of using investment gains from conventional investments to do ESG work on a local level, by donating to organizations aligned with your values and/or participating in causes that reflect your ESG goals.

Bottom Line for Investors

The ESG investment insights mentioned above are not meant to deter or encourage anyone to invest in ESG funds. Like any long-term investment, it is important to consider if investing in ESG funds aligns with your goals and objectives, and you should examine each investment opportunity objectively – understand what criteria is used to make it an ESF investment. Finally, if you want your investments to reflect your values, just remember that there are more ways to accomplish such a goal than just investing in ESG funds.

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1 NASDAQ, July 6, 2020.

2 The Wall Street Journal, October 4, 2020.

Past performance is no guarantee of future results. Inherent in any investment is the potential for loss

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