If you care about how your choices affect this gorgeous green planet, it’s time to talk about socially responsible investing.
What are ESG funds?
ESG stands for environmental (like climate risk management, how they use water, pollution, and waste) social (workplace health and safety, diversity equity and inclusion, human rights.) and governance (transparent reporting, board structure, shareholder rights, etc.) To be considered an ESG investment, a company must strive to make the world a better place. Right, sounds good.
In 2023, ESG funds crossed $2.3 trillion in assets.
Let’s consider the methodology behind determining where a company falls on an ESG scale. Perhaps you’re not familiar with it, many aren’t. That’s due to the fact there’s no commonly accepted measurement that decides whether a company is good or bad. No hard defined rules for what designate a company as “socially responsible” or “climate friendly.” In fact, a fund provider can slap an ESG label on a fund and call it a day. Right now, it’s the equivalent of the emperor in Gladiator giving the thumbs up or thumbs down.
There are generally two ways to think about socially responsible investing. The first one is fairly straightforward; investors avoid companies whose business practices run counter to ethical principles: think defense contractors. The second type is where investors seek out companies that prioritize social impact, like companies that mandate diversity and inclusion practices or are carbon net zero.
At the end of the day, you vote with your dollar and decide whether a company is moral–there’s no right way to be responsible and invest. But investing with your heart and investing by the numbers are two different exercises (and will produce two very different results) We understand decisions should reflect one’s values, but very often we’re unlikely to find an ESG fund that truly reflects those values. The devil is in the details.
But you want to do good.
Milennials are more active than older generations in addressing climate change, both on- and offline.
One-third of millennials often or exclusively use investment products that take ESG factors into account and are more willing to suffer losses in the name of good governance.
According to a McKinsey US consumer sentiment survey, more than 60 percent of respondents said they’d pay more for a sustainable product. There’s good money in going green.
If this is you, good on you.
But, what about Wall Street?
Well, like junk bonds in the 80s, and tech stock IPOS in the 90s and the 2000s housing crash, Wall Street took notice. Wall Street is there when there’s a buck to be made and a market to sell to. In fact, some project that ESG assets are on pace to constitute 21.% of total global assets under management in five years.
It’s in Wall Street’s best interest to market these funds.
More millennials prefer lower-fee ETF and Index funds compared to mutual funds. Picture your typical millennial: fee-savvy, environment-conscious, and DIY.
But, on average, Wall Street makes more money on ESG funds compared to non-ESG funds. 40% more.
It’s in their best interests to market these funds to the next generation of investors. And they did. They created every type of ESG fund under the sun. Do you want to invest in companies that don’t pollute the air? You got it. How about a fund that promotes gender and racial equity on their board? Done. Are you into protecting our forests? Consider them protected with an ETF. How about a side of carbon neutrality? Easy. If you’re buying, they’re selling.
To recap, a company labels a fund as ESG, markets that fund, and charges a premium for it.
But what are these funds, really?
ESG funds are supposed to promote the heroes and block out the villains, but let’s compare the top ten holdings of two very popular ETFs, the RBC U.S. Equity Index ETF Fund, and the iShares ESG Screened S&P 500 ETF.
Can you spot the difference? Other than the ESG tag, neither can we.
The companies managing ESG ETFs understand the importance of not neglecting fundamental analysis in favor of fleeting, feel-good trends. To further this point, let’s take the biggest ESG holding: Amazon. Amazon’s alleged corporate governance practices, employee treatment, anti-union stance, and sustainability concerns, resulted in an ESG score of 30.6, placing it in the same high-risk class as BP Oil.
Speaking of ratings.
Okay, so maybe catchall index funds are not a great option. How about individual companies?
Let’s look at the ESG scores of two very opposite companies in two different sectors: Beyond Meat and General Motors. Which of the two companies do you think has a better score for social, environmental, and governance standards?
One builds gasoline and electric-powered cars and trucks. The other provides plant-based meat substitutes designed to replicate the taste and texture of animal-based meat products. The answer seems obvious as the companies apparently sit on opposite sides of the conservation conversation.
In fact, they do sit on opposite ends of the ESG rating spectrum, just not as we expected. GM’s score is 28.5, “medium risk.” Beyond Meat scores a healthy 41.7 with “severe risk.” On the plus side, they don’t have a “significant controversy” in the last three years, and we have to give them credit for bringing plant-based vegan meat to the top of the general public’s mind. On the other side, GM donated $60m to nonprofits in 2022 and was acknowledged for supporting employees through COVID with $1b towards one-time payments, job guarantees, and access to mental health and other support services.
Beyond Meat has a low E score because they don’t let marketing get in the way of sourcing their ingredients, and that’s straight from a manager of consumer goods research at Sustainalytics:
“We don’t feel we have sufficient information to say Beyond Meat is fundamentally different from JBS.”
Yet marketing has definitively told us that plant-based meat is good for the environment.
ESG scoring is arbitrary.
Investing in an ESG ETF may seem similar to other lower-cost broad-market ETFs, but it simply adds a buzzword while significantly increasing fees. Now that you know better, it’s time to change the approach. If you want to invest with a clear conscience and avoid sacrificing returns, it’s time to rethink ESG-labeled funds and explore more effective ways to make a positive impact with your investments.
How to make a meaningful impact.
We’ll start with what not to do: Stop investing in catch-all ESG-labelled funds. They’re misleading and highly correlated to “normal investments.”
Start by figuring out what it is you’re really trying to accomplish. If you’re trying to do well for the environment, take your money and do it. Be charitable.
If you want to profit and grow your accounts, invest. You could set up a dividend-producing account and take the profit to support whatever cause you’d like.
Let’s go.
Ready to back up your words with action? Let’s convert those honorable intentions into meaningful steps. It’s important to clarify that not all ESG initiatives are ineffective; we share the desire for a fairer society, addressing climate change, and promoting human dignity. We’re here to offer a few direct ways to help you achieve the impact you’re passionate about.
- Buy local products. While organic food might be your preference, how much emissions are generated when it’s transported from another country?
- Read up on social capital ventures like The Rise Fund.
- Donate your cash to immediate sources of help, such as aiding natural disaster relief or supporting families who have lost their homes. Both these situations require urgent attention, and your financial contribution can have a more immediate impact.
- Buy municipal bonds that directly invest in the local community.
- Consider fair trade-certified products.
- Vote with your time, not your dollar, by volunteering.