One of my clients with several million dollars in investments has a deep passion for protecting the environment. As a result, I’ve invested a part of her portfolio in companies with good records in environmental, social and governance practices.
With social causes escalating to new heights in 2020, more investors want to know how they can align their investments with their values. They want to invest in companies committed to a variety of causes, ranging from racial equality to clean energy and those committed to proper corporate governance — meaning they focus on issues including fair compensation for all employees and diversity in the workforce, among others.
In response, more companies are upping their commitments to support these causes. In early October, for example, JPMorgan Chase announced new long-term commitments to advance racial equity, committing an additional $30 billion over the next five years to provide economic opportunity to underserved communities, especially Black and Latino communities.
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Investment firm Blackstone Group, one of the world’s largest owners of real estate, has set a goal of reducing carbon emissions by 15% within the first three years of buying any asset or company across its portfolio. The initiative will begin in 2021 and will apply to new investments where Blackstone controls the energy systems.
What Is ESG, and Where Do You Start?
ESG — or environmental, social and governance — investing is a growing field (an interchangeably used term is “Socially Responsible Investing”). Recent data from financial services firm Morningstar shows continued investor interest in ESG. The global sustainable fund universe attracted $45.7 billion in the first quarter of 2020, versus an outflow of $384.7 billion from the overall fund universe.
Some people willing to consider an ESG portfolio worry that by limiting their investment universe to suit their social concerns, they will sacrifice financial returns. But with today’s sophisticated investment portfolio software, that’s not necessarily the case. A 2019 study by Morningstar found that 73% of the 56 Morningstar ESG indexes outperformed their non-ESG screened equivalent indexes, from 2012-2018.
However, many people who want a socially responsible portfolio that will still produce strong financial returns aren’t sure where to begin. If you want to explore setting aside a portion of your investments in an ESG portfolio, here are a few recommendations to get you started:
You Can Single Out Industries You Insist on Excluding
Many investors begin by avoiding certain companies or sectors. For example, one of my clients asked me to remove any company in the tobacco, alcohol and casino industries from their portfolio. That can’t be done with a mutual fund or index funds, so we created a portfolio of individual stocks that excludes those.
In this case, we had a custom portfolio designed by an ESG manager that allowed us to screen out those companies. It also tells us how to weight the stocks we do own so that the expected deviation of returns compared to our benchmark is within the limits that we and our client desire.
Or You Can Identify One Issue You’re Passionate about to Support
Rather than avoid certain companies or sectors, other investors are passionate about key issues and want to allocate their dollars in companies directly related to this cause.
When I built the portfolio for my client committed to the environment, we focused on mutual funds that screen for companies that they deem to be environmentally responsible to help her reach her goals.
Understand There Are Still Risks
Moving part or all of your portfolio into ESG companies isn’t without financial risk. For example, if any investor interested in only sustainable energy sources wants to avoid oil and gas companies, it could cause their portfolio to be overweight in other sectors. Make certain your adviser has struck a proper balance when constructing your new portfolio.
Find a Firm or Adviser Knowledgeable About ESG Funds
Many Registered Investment Advisory (RIA) firms will have individuals with some experience in building an ESG portfolio. They will work with their firm’s investment committee and use software designed to find companies that align with your values while still providing the returns designed to help meet your financial goals. At the same time, an experienced adviser can help build a portfolio that is also sensitive to fees and taxes.
While it may have been difficult 20 years ago for a socially responsible investor to fill their portfolio with companies that meet their values, those days are long gone. And, with concerns about climate change, economic inequality and other social movements afoot, there should be plenty of opportunities to find the companies or sectors to align your financial goals with your personal values.
