ESG investing: Off the sidelines and into the mainstream

As early as the 19th century, some groups – such as the Quakers and anti-abolitionists – took a stand on investing in anything in conflict with their values. As the decades rolled on, tobacco, alcohol, gambling and firearms became known on Wall Street as the “sin stocks.” But to a large extent, investors who wanted to “do well by doing good” were relegated to the sidelines. Today, however, Environmental, Social and Governance – or ESG – investing has gone fully mainstream. With assets expected to surpass $50 trillion by 2025, according to Bloomberg, it’s now a large part of the investable market.

Modern ESG investing has its roots in the 1970s with the rise of “socially responsible investing.” It was seen as a specialized investment strategy that offered a way to make a statement about values that mattered to you – but that typically didn’t offer competitive returns.

In 2000, the term ESG was first used as part of the United Nations Global Compact, which sought to encourage the integration of human rights, environmental and anti-corruption efforts into capital markets. The compact was widely adopted and resulted in new regulations by governments and agencies around the globe. At the same time, there was growing public concern about climate change and social issues. The combination of factors had helped drive tremendous growth in ESG investing.

Investments into ESG mutual funds and Exchange-Traded Funds totaled $355 billion in 2020. By the third quarter of 2021, it was estimated that inflows into these funds had already reached $577 billion, according to Barron’s.

ESG investing is no longer simply a matter of excluding investments like tobacco or gambling stocks – although there are funds that offer exclusions. And it’s not limited to “sustainability” – although that is a big part of ESG considerations. The concept has evolved to include nuanced risk/reward analysis of a company’s financials, when viewed through the lens of ESG-related factors. Analysts assign an ESG rating to companies based on their overall adherence to ESG standards. While these can vary widely across investors and fund managers, overall ESG funds will take one or more of these standards into account, and then:

• screen out companies with poor ESG ratings;
• screen out companies that pose high ESG risks; and/or
• choose to overweight or invest exclusively in companies with higher ESG ratings.

At Edelman Financial Engines, we offer ESG-themed models that follow our established investment philosophy. We use data from Morningstar, an independent research and fund rating firm, to review low-cost ESG mutual funds and ETFs that are highly diversified. We then do further proprietary research to ensure these funds can offer attractive risk-adjusted returns and the appropriate asset class exposures. This approach allows us to give interested clients the option to reflect their preferences while benefiting from an investment strategy to help reach their wealth planning goals.

You may want to consider ESG portfolios if you are concerned about environmental, social and governance issues. If you are interested in exploring this and learning more, contact an Edelman Financial Engines advisor.