The Growth of ESG Funds and What to Look For

The Growth of ESG Funds and What to Look For

Green is the new black, as environmental, social, and governance (ESG) equity has outpaced the growth of both US and EU equity flows in the past years.

ESG funds are assets that incorporate sustainable impact metrics to generate investment returns. As consumers and investors shift their concerns towards issues around sustainability, ESG funds are now becoming a popular choice for fiduciaries. In 2018 alone, sustainable investments in the five major markets — Europe, U.S., Canada, Japan and Australia/New Zealand—reached $30.7 trillion.

In fact, for many companies, sustainability has become synonymous with attracting capital. So, what exactly are these ESG funds and how do you invest in them?

Sustainability and profit

ESG investing entails evaluating potential stocks in your portfolio that promise to deliver an impact on sustainable goals for the three aspects of the acronym. Lower carbon footprint, water-related issues, environmental benefits, and renewable energy are some of the key environmental impacts. Social impacts include good employee pay and benefits, ethical supply chains, and diversity in the workplace. Corporate governance metrics include transparency, board diversity, and low lawsuit records.

For years, ethical or sustainable investing was a niche market where investors accepted lower returns in exchange for more ethical and better outcomes. However, CNBC reports that recent estimates from the International Monetary Fund (IMF) suggest that ESG funds perform the same as those not labeled as sustainable. Factoring in long-term considerations, sustainable funds add value to their investors beyond the short-term revenue. An FXCM primer on ESG investing details how there is a known correlation between robust sustainability practices and better operational performance—translating to higher profitability. Investors put their money in ESG funds because they want their capital to make a difference in the world while also pocketing the generated revenue.

Standardizing ESG

While these look like win-win situations, the IMF report also notes that there remain challenges in the burgeoning investment space, as corporate reporting on ESG impacts are voluntary. Data measurability and availability are also hurdles in quantifying the impact of these ESG funds.

While frameworks like the United Nations’ Principles on Responsible Investments and watchdog groups like the Global Reporting Initiative have been improving impact transparency, it’s still lagging behind. In fact, better ESG regulations that would improve standards and transparency will help sustain its growth.

ESG integration and strategies

If not for the above, ESG investments are also seen as indicators of good management practices. Companies that neglect climate, inclusivity, and governance impacts are increasingly considered as risks given the changing investment landscape. There is also plenty of data that shows that ESG companies are well run and have less volatile stocks.

Institutional investors and fiduciaries often integrate the ESG approach with the more traditional social responsibility investment (SRI) and the more recent impact investing. SRIs exclude stocks that are not aligned with the goals of investors such as those involving fossil fuels and coal. On the other hand, impact investing invests in funds directly in service to the UN’s Sustainable Development Goals. Integrating these three approaches, for now, are the best way to ensure your investments have a high impact.

The changing regulations and increasing concern of investors in the modern world will surely propel ESG investing into the mainstream over the next few years. By investing now, you are getting ahead of the curve.