If you pay attention to the the asset management industry long enough you will notice trends that come and go as the companies that profit from offering investments come up with new ways to “mark up” the assets they offer by making something that is pretty simple seem more complex.
Before the financial crisis global and emerging markets investing was the trend, while directly after the crisis “alternatives” that limited market risk became in vogue. Needless to say both trends offered more profits to the asset management companies than the investors themeselves.
The latest asset management trend is ESG investing, which seems to be meeting its moment by offering investments that align with broader societal values.
ESG stands for: environmental, social and governance factors, which fund managers and index providers use to assess the sustainable qualities of the investment, alongside how profitable it is.
Some ESG funds are exclusionary, meaning they will cut out entire problematic sectors such as fossil fuels and weapons makers, while other approaches use a “best-in-class” approach which seeks to reward companies that are the least problematic within their industries and are making strides in the right direction on the ESG factors.
ESG investing has been around for many years in multiple previous carnations including SRI (socially responsible) and values-based investing, the latter of which now more likely refers to religious investing.
ESG investing has gained popularity among investors in recent times for two primary reasons:
- Many investors increasingly object to problematic corporate practices that contribute to major societal issues such as global warming, income inequality and anti-competitive behavior, and want to express those values within their portfolios.
- Research is now showing that paying attention to ESG factors can actually lead to outperformance of the broader market. It was previously assumed that valuing ESG factors would “cost” investors some percentage of performance as many problematic companies socially are also quite profitable (military defense firms as an example). Long-term and short-term performance studies are beginning to tell the opposite story however.
How ESG Paid Off During the Coronavirus Crisis
A brief example into how ESG investing may have paid off for some investors recently includes looking at the coronavirus market crash. An investor that held an ESG fund as a core portfolio position instead of the broader S&P 500 index.
If we look at the YTD performance of Vanguard’s ESG US Stock ETF (ESGV) compared to the mainstream S&P 500 SPDR ETF (SPY), we see that the ESGV fund has significantly outperformed SPY, the former down just 2.5% compared to more than 5% loss for the broader index.
What explains this significant performance difference?
- The ESGV fund has basically no energy holdings whatsoever. Energy, as you may recall, was absolutely crushed during the coronavirus market sell-off, with oil trading below $0 at one point, taking energy companies down with it. This gives you a clue as to how ESG funds will perform. When sectors such as energy and defense firms are doingly poorly, ESG-focused portfolios will outperform, but the corollary is also true: when energy stocks rally, ESG investors have to be prepared to sit those gains out.
- While energy has been the big loser of the market crash, technology was the perhaps the biggest winner. ESG funds tend to be overweight technology firms, as these stocks tend to have relatively lighter environmental footprints compared to legacy businesses. A look at the portfolio of ESGV for example reveals top holdings in the likes of Microsoft, Apple, Amazon and Facebook, all of which suffered less badly during the sell-off and recovered more quickly than many other companies in other industries.
What Qualifies as ESG, Anyway?
Readers unfamiliar with ESG might be interested to see Amazon as a highly rated holding in an ESG portfolio, and we have to agree. Amazon has been at the forefront of issues related to employee benefits and compensation, especially for its front line warehouse and delivery workers who have to face the greatest coronavirus risks. There is also a debate to be had about Amazon’s environmental footprint, with its rapid delivery of almost any consumer item obviously contributing to greenhouse gas emissions.
Amazon’s inclusion as an ESG company gets at the central problem of the concept of the sustainable investing trend. That is, “ESG” is mostly in the eye of the beholder (or creator of the portfolio). Many ESG providers that rate the companies that should be included or excluded rely on relatively complicated (and proprietary) formulas that factor in issues such as executive pay, employee benefits, carbon footprints and female and minority representation on corporate boards. Most importantly, these issues are often factored in for how they are improving and not just a single point in time. So a company that could be perceived as not particularly sustainable may be rewarded and ranked higher than expected based on improving its metrics compared to how it rated five years ago.
When you look at many of the top holdings in ESG ETFs and mutual funds, it often feels like ESG investing is just a shiny new wrapper that asset management firms have placed around sectors such as technology and alternative energy in order to charge an extra few basis points in management fees.
Are big Pharma companies ESG approved? In most major ESG funds, they are. What about Wall Street investment banks? You will also find them among some of the top holdings in ESG portfolios, too.
Investors interested in ESG can either choose to accept that a “best-in-class” approach that rewards certain behaviors (even among companies that might be objectionable overall) are a net positive for society or build out your own ESG portfolio through careful stock selection. The alternative is simply to ignore the concept all together and buy the stocks you think will be most profitable and leave sustainability concerns to your philanthropic and political activities, if you are of that persuasion.
How to Invest in ESG Stocks on Robinhood
There are two simple ways to invest in ESG stocks on Robinhood. Buy an ESG ETF such as ESGV, or buy your own stocks as a result of your own research and values.
If you choose to go the fund route there are many for you to choose from, both US and globally focused. In addition to Vanguard’s ESGV, which is a fine choice for US stocks, iShares offers both ESGD for international developed companies and LDEM for emerging markets companies with strong ESG characteristics. Just remember when you buy a fund you will be investing in the ESG ratings that are determined by a large company and will not necessarily 100% align with your own values.
As an individual investor concerned with sustainability, you may also pick and choose the stocks you feel comfortable with. A great starting point is to review the portfolios of the funds above and try to understand why these stocks rate so highly as ESG choices. From there, you might visit the company’s web site and review their CSR policies and search the news for how well the firm is living up to its objectives.
Here are some of the most common highly rated ESG stocks, all of which are available to buy on Robinhood:
- Tesla (TSLA)
- Microsoft (MSFT)
- Nvidia (NVDA)
- Emcor Group (EME)
- Nike (NKE)
- Visa (V)
- MasterCard (MA)
- Intel (INTC)
- Home Depot (HD)
- Amgen (AMGN)
One challenge with ESG investing is that there is realistically no one size fits all approach for ESG. Some investors may care quite a bit about global warming without being overly bothered by CEO pay. Another investor may rate diversity as the highest priority while not being as concerned about the type of products the company sells.
When you invest in individual stocks you can more finely tune your ESG concerns to your exact situation, but you are also taking on more of the burden of research, both in terms of the sustainability of the company and its viability as a profitable investment. The last point is key: you need to identify companies that can do well by doing well, otherwise you are contributing to a charity and not an investment.