ESG Funds: The More Ethical and Profitable Future of Investing?
Have you ever stopped to think about where your money is actually going when you open an investment account or pension? For many people, the answer is “no”—but if you’re reading this, chances are you’ve joined the increasing numbers opting for a more ethical approach. This is all about choosing assets with a positive impact on society, also known as ESG funds.
What’s better than checking your investment portfolio and seeing some juicy returns? Knowing that you haven’t achieved those returns by fueling dirty industries like tobacco, gambling, and weapons production. Once upon a time, that might have sounded like a pipe dream, but environmental, social, and governance (ESG) funds have grown significantly in popularity over recent years.
You shouldn’t have to compromise your beliefs just to grow your wealth and secure your financial future. It’s perfectly possible to invest in a way that aligns with your values, and every day it’s getting that little bit easier. Let’s take a look at what ESG funds are and the pros and cons of making them part of your investment strategy.
ESG funds explained
It’s an unfortunate truth of investing that many of the best-performing assets out there have a dark side to them. Just look at the S&P 500—how many of those companies do you think contribute to social problems like climate change, weapons manufacturing, and exploiting developing countries?
Around 3% of the index consists of oil and gas companies alone, and you can imagine how many more have been involved in less-than-ethical decisions. For instance, Nestle might not flag up as a “sinful” stock since it’s a food and beverages company, but its Chinese milk scandal shook the world.
If you’ve ever thought to yourself, “there must be another way,” there is—it’s called environmental, social, and governance (ESG) funds. And considering investors now hold $17.1 trillion worth of ESG assets—up from $12 trillion just two years ago—they’re worth paying attention to.
What classes as ESG funds?
As you’ve probably figured out by now, ESG funds focus on companies that do at least one of the following:
- Protecting the environment or fighting against climate change
- Looking after their customers/employees or helping their local communities
- Having a governance structure that’s fair and transparent
ESG funds usually come in the form of either ESG mutual funds (which aren’t traded during market hours) or index funds (traded during market hours). Either way, they contain a mix of different company stocks.
But what exactly does a company have to do to meet the criteria above?
Every fund provider uses their own criteria and may weigh factors differently, but there are some common themes.
For environmental aspects, a fund provider could assess how much energy a company uses (and what type of energy) or check if it’s been involved in any ecological scandals.
When it comes to the social sphere, criteria could focus on the percentage of profits a business uses to help its local community or other social causes and check which steps it takes to look after employee welfare.
Finally, when it comes to governance, funds might check whether a company is lobbying politicians or hiring board members that could cause conflicts of interest. These are all examples of ways to easily quantify or check how “ethical” a firm really is.
Companies might also be excluded because they’ve been involved in recent scandals or are part of dirty industries (such as fossil fuels, tobacco, and weapon manufacturing).
Why people invest in ESG funds
ESG investing is more than just a nice idea—it’s really taken hold. And there’s one group in particular that has flocked to it: the younger generations. One report suggested that 76% of those born between 1965 and 2000 thought ESG investment was important; just 37% of those born in 1964 or earlier thought the same.
Millennials and Generation Z in particular have grown up bombarded by messages about climate change and social issues, so it shouldn’t come as a surprise that they’ve been eager to look for ways to act on this information and do their bit in the world. They’ve also had the benefit of having readily accessible information to educate themselves about social issues, investment trends, and ESG investments.
But you should make your own mind up—so here are some pros and cons to consider.
The first benefit of ESG funds is pretty obvious: you’ll be investing in companies that positively impact the world, which is a pretty big plus. Why wouldn’t you want to be a conscious investor given the choice?
But this isn’t just a charity case. The best ESG funds often outperform their non-ESG equivalents. For example, 18 out of 27 ESG funds surveyed by S&P Global Market Intelligence data saw returns between 11% and 29.3% between December 2020 and May 2021. Meanwhile, the S&P 500 rose by 10.8%.
Many would argue that this effect will only increase over time. Events like COP26 have shown that governments are finally beginning to take environmental concerns more seriously, and the interest of young generations proves that demand is likely to increase too.
Reasons for caution
ESG benefits are clear, but it would be dishonest to claim there are no potential problems.
We’ve said already that there’s no fixed universal criteria to determine whether a company truly has a positive environmental, social, and governmental effect. Some fund providers are stricter than others, which means investors can sometimes be surprised to learn which investments really make up their portfolio.
Many companies are guilty of greenwashing or “woke-washing”—a firm marketing itself as more ethical than it really is to drive demand. Major corporations that most people wouldn’t consider ethical—like Goldman Sachs—are also increasingly turning to ESG strategies.
And don’t forget that it’s still early days, meaning there are more investment risks to consider. Even if you feel 100% certain that ESG funds will take off, there’s no telling if the companies that are part of your ESG funds will be the ones that end up taking off. Some companies will get overtaken by competitors hiding in the shadows now, and some leading green technologies may get overtaken by superior solutions that haven’t yet been invented.
Invest with MyConstant
If you’re sick of the financial system and the status quo, ESG funds aren’t the only way to start doing things differently. Cryptocurrencies and decentralized finance solutions also offer a welcome alternative to “the old way”—and at MyConstant, we have a proud record of no investor losing their initial investment to date, meaning minimal risk exposure along the path to morality.
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