The Truth Behind 4 ESG Investing MythsNovember 15, 2019
Environmental, Social and Governance (ESG) investing…just a passing fad, right? We debunk this and other myths tied to this investment strategy.
After 20 years, Environmental, Social and Governance (ESG) investing has entered the mainstream. While the number of ESG classified funds in the marketplace has tripled in the past 15 years, there still seems to be many misconceptions about the investment strategy. Some of these myths include that ESG investing is just a passing trend that leads to unbalanced portfolios and potentially lower returns. The numbers tell a different story; 81% of investors want their investments to deliver competitive returns while promoting positive social and environmental outcomes. Also, 93% of millennials say they would be likely to put all of their investment holdings in responsible investments.
Let’s dive into some of these myths.
- ESG is a passing fad
Some investors dismiss ESG as a potential one time trend in the marketplace. Investor sentiment has fallen in line with the fact that since the majority of portfolios do not pay attention to ESG factors, why should they?
The truth of the matter is, ESG has garnered a lot of interest. Across the U.S., over a quarter trillion dollars is invested in ESG, tripled in the past 15 years. Trends come and go, but this growth story has lasted for 20 years, and continues to grow, so it looks like ESG is no passing trend!
- ESG is just tied to environmental issues
For some investors, ESG investing is only tied to the concept of environmental issues. This may be because environmental issues are front and center in today’s world. One factor that is grossly overlooked is governance - the “G” in ESG. Governance addresses business ethics, corruption and board pay policies…concepts that most investors can support, regardless of where they stand on environmental issues.
- ESG will put me overweight/underweight in certain sectors
Asset allocation is an important part of any investment portfolio (check out our blogs The (Real and True) Benefit of Active Asset Allocation: Part 1 and Part 2), so won’t an environmental and social approach leave portfolios underweight in sectors like energy, materials, etc? An underweight portfolio occurs when the percentage (or weight) of a particular security is lower than what is held in the benchmark portfolio. The potential issue that becomes elevated in this ESG scenario is the possibility of leaving a portfolio lopsided relative to more standard benchmarks.
Herein lies why the working with an advisor to advise on and allocate assets appropriately is important. An advisor can look at the overall ESG portfolio through a “sector-neutral” lens. Investors will get market exposure across appropriate sectors leaving a well allocated portfolio with the inclusion of ESG.
4. Investment returns will be sacrificed
Doing good sometimes must come at a cost – one of the most damaging myths surrounding ESG portfolios is that they will underperform a traditional portfolio – recent research shows that this is largely unfounded. Not only have companies with high ESG ratings generally posted lower earnings volatility, but companies with sustainability practices have demonstrated better operational performance. Furthermore, 90% of study results showed a positive link between sustainability and investment performance, suggesting worries over a likely lower return are without merit.
After taking a closer look at some of the main myths, concerns over outsized costs, negative performance and implementation should not prevent you from investing in ESG. Investors are embracing the real story behind responsible investing. Many are already starting to embrace ESG principles for not only their investments, but general day-to-day life as well.
KLR Wealth Management has worked closely with research partners to develop ESG portfolio strategies. Contact us.