So, you buy an ESG mutual fund or ETF and you’re excited that you’re going to change the world with your investments. But then you get your annual report and start browsing through the holdings and realize that your ESG fund is simply less bad than your traditional index fund, and reality sets in. This isn’t what you thought it was.
This happens all the time because there is no regulation when it comes to labeling funds as “ESG” or “sustainable” or anything else in the responsible investing realm. It’s the wild, wild West, buyer beware, every red flag you can think of.
Ultimately, the disconnect happens because there isn’t a universal understanding of what ESG (environmental, social, governance) or sustainable investing is. We think that it’s all the same and we want to jump in. And the people marketing ESG funds assume that you’re not going to take the time to look under the hood to see what you really own, and they take advantage of that. But it truly does a disservice to those of us who really care about making a difference in the world and aligning our investments with our values.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Too often these ESG index funds rely on traditional indexes as a base from which to invest. The problem with this is that the traditional indexes are rooted in the old economy, and you can’t invest for the new economy by looking in the rearview mirror.
The Difference Between ESG and a Sustainable Portfolio
ESG is a way of analyzing companies based on the three metrics it’s named for. It is not the be-all, end-all of the investment research process – it’s just a piece and should be considered as one component of comprehensive investment research. However, many index-based fund managers put together portfolios using only ESG metrics and very little common sense. They eliminate the step where a person asks, “Does it make sense that ExxonMobil is in a sustainable or responsible portfolio?”
By contrast, a truly sustainable portfolio is focused on a positive, solutions-based approach. What are the companies that are going to help us adapt and be more resilient to the structural and systemic risks that we are facing? It uses ESG metrics, but also looks at a new, more sustainable economy and the opportunities it presents.
I like to look at it this way: An ESG portfolio that reduces its allocation in ExxonMobil is less bad. A portfolio that eliminates it entirely is better, but a portfolio that buys First Solar (FSLR) in its place is both sustainable and responsible.
To Be Sustainable, You Have to Go the Extra Mile
A sustainable portfolio requires forethought and analysis beyond basic fundamentals and ESG metrics. It includes understanding the new economy and which technologies, sectors and industries are going to be market leaders and changemakers. In some cases, it might be traditional industries that are rapidly adapting, or it might be a technology that didn’t exist five years ago. It could be sustainable real estate and green building technologies or the rapidly expanding world of batteries, electric vehicles and other forms of green transportation. And beyond the obvious like clean energy, opportunities exist in cutting-edge biotechnology to cure disease and help people live longer, healthier lives. A healthier society is a more sustainable society.
If your ESG fund isn’t actively looking at its holdings from a similar solutions mindset, then it isn’t sustainable.
What You Should Do as an Investor
The best way to avoid the greenwashing that is happening in the ESG investing world is to do some basic due diligence. Before you buy a fund, take a look at its holdings – if something doesn’t seem right, it probably isn’t.
Don’t just trust the label because the reality is that virtually all of the widely distributed ESG indexes aren’t sustainable. Find an investment manager who actively invests in solutions to the world’s greatest problems and avoid the ones who are simply trying to be a less bad version of traditional indexes.
-
More SECURE 2.0 Retirement Enhancements Kick in This YearSaving for retirement gets a boost with these SECURE 2.0 Act provisions that are starting in 2025.
-
Saving for Your Emergency Fund: As Easy as 1-3-6An emergency fund that can cover six months' worth of expenses is far easier to build if you focus on smaller goals at first.
-
More SECURE 2.0 Retirement Enhancements Kick in This Year
Saving for retirement gets a boost with these SECURE 2.0 Act provisions that are starting in 2025.
-
Saving for Your Emergency Fund: As Easy as 1-3-6
An emergency fund that can cover six months' worth of expenses is far easier to build if you focus on smaller goals at first.
-
The Wrong Money Question to Ask After Trump's ElectionIf you're wondering what moves to make with a new president moving into the White House, you're being dangerously shortsighted. Here's what to do instead.
-
An Investing Plan for This Year: Doing Less Can Lead to MoreAchieve more when investing in 2025 by planning to work smarter, not harder. These three strategies can help put you on the right track and keep you there.
-
All About Six Types of Auto Insurance CoverageDo you know what your auto insurance policy covers? Here's a primer on some coverage categories, along with examples of how each type of coverage works.
-
Social Security and Medicare Funding: Is the Sky Falling?Social Security and Medicare are slowly running out of money, but what does that mean for the retirees counting on them? Actually, it's not all bad news.
-
What We Need to Do to Protect Retirees' Financial SecurityCognitive decline and aging in general put older retirees at risk of losing their financial security when they're the most vulnerable. What can be done?
-
Is Money Messing Up Your Family's Life?Parents who discuss money and attitudes toward money with their children are more likely to raise financially successful and responsible adults.
