Investing in ESG stocks has grown significantly in popularity in recent years.
We want to explore the history and meaning around ESG stocks and why the best ESG stocks can do wonders for your investing portfolio. We will review our top ESG investing mutual fund and stocks for 2021 and beyond.
Reviewing powerful examples of our top ESG stocks will give you a feel for the characteristics to look for to fill out your portfolio.
ESG (which is an abbreviation for environmental, social and governance) investing is the idea of investing in companies that are not just providing attractive financial returns. ESG investors also demand that the companies that they invest in are also doing good things for environmental, social, and corporate governance causes.
ESG investing is sometimes referred to as “sustainable investing” or “socially responsible investing” or “impact investing”. While all of these labels have slightly different meanings, they all relate to the idea of a business doing good for the planet/society at the same time the business is making money for its shareholders.
ESG investing has been around in some form for many years. This is because some investors have always shied away from certain stocks because of the business they were in. As an example, some investors have always shied away from “sin stocks” like tobacco and alcohol because they disagreed with the idea of people consuming these products.
But ESG type investing really started to gain momentum in the 1960s when college students pressured their universities, rather successfully, to not have their endowments invest in defense contractors because the students were protesting the United States involvement in the Vietnam war.
If you are going to invest in ESG type stocks you will want to develop a criteria to determine which kinds of companies you will invest in and which ones you will refuse to invest in.
The most basic form of ESG investing is to develop a criteria that says you are not going to invest in certain types of stocks. Tobacco, alcohol and defense contractors discussed above are three good examples of the kinds of stocks ESG investors might decide to stay away from as they make their investing decisions. These are examples of not investing in companies that are clearly doing harm to society.
A more complex form of ESG investing is to only invest in business that clearly demonstrate that they are doing good for society. This might come in the form of a company committing to be neutral for carbon emissions by a certain date (environmental good). Or the company can demonstrate that they are giving back to the communities they serve by giving a percentage of their profits to local charitable organizations (social good). Or finally a company can demonstrate that executive pay is reasonable or that it has a diverse leadership team (governance good).
Either of these types of criteria are appropriate for an ESG investor. The first one involves screening out companies that are clearly doing harm. The next one, which has a higher bar, is screening in companies only if they are doing good things for society.
To make it easier for investors, there are companies like MSCI that do the work for you, giving many companies ESG ratings on a scale from AAA to CCC.
Recent reports indicate that ESG type assets under management account for as much as 33% of total assets under management in the United States. This is a huge percentage of assets for a single investing theme and one where the major Wall Street firms have taken notice.
It is relatively easy to understand the popularity of ESG investing, because everyone wants to think they are doing something to make society a little better. Let’s say you were planning to invest in a utility. Your research narrows it down to two utility companies for a possible investment. The first one generates a large percentage of its electricity from coal fired plants that pollute the environment in a significant way. The second utility generates most of its electricity from renewable sources like solar and wind making it very close to carbon neutral.
Most people in the above scenario would choose the second utility, regardless of whether they had heard of the concept of ESG or not. This is because, all other things being equal, everyone wants to invest in businesses that are doing more good, or at least less harm, to the environment.
Outsource the heavy lifting to a mutual fund.
ESG investing requires an investor to set up a criteria of which types of companies they want to invest in and then monitor those investments over time to make sure things are still on track for environmental, social and governance initiatives. This is in addition to monitoring financial performance.
Many investors do not have the time or the needed experience to properly establish and maintain an ESG criteria. The good news for these types of investors is that they can easily outsource this work to a mutual fund manager.
A great example of a successful ESG fund or impact fund is Vanguard FTSE Social Index Fund (ticker VFTAX). This fund avoids companies involved with alcohol, gambling, tobacco, fossil fuel and adult entertainment to name a few. It also avoids companies that have shown “controversial conduct and diversity practices”.
Its top five holdings are a who’s-who of well-known brands – Apple, Microsoft, Amazon, Facebook and Alphabet/Google. Hard to argue with any of those five names for long term performance given their current profitability and growth potential.
Best of all the Vanguard FTSE Social Index Fund has a five year average annual return of 15%+, so you are not sacrificing financial performance by investing in businesses that are making the world a better place for all of us.
This is a great fund for just about any kind of investor. Particularly new investors should start with a small position and grow it over time as they get more comfortable with the fund and its investing style.
If you are a little more knowledgeable and adventurous, you may want to create your own ESG criteria for this part of your investing portfolio and then select stocks that are operating successfully within those parameters.
You may say that you want to stay away from businesses using fossil fuels and only invest in companies using a significant amount of renewable energy. For someone with this ESG criteria, you may want to look at NextEra Energy (ticker NEE). NextEra Energy is one of the largest utilities in the United States with operations primarily in the southeast. It generates much of its electricity from renewable sources like wind and solar, making it loved by the ESG investing community.
Or your ESG investing criteria many say that you only want to invest in companies that are committed to carbon neutrality within a reasonable timeframe in the future. Companies like Microsoft and Home Depot are examples of businesses that have made such a commitment to be carbon neutral in the near future, making them loved and respected by ESG investors. Both companies publish periodic updates on how they are progressing towards their goals.
Perhaps your ESG investing criteria includes wanting to invest only in companies that give back to the communities that they serve through either donations to local charities or giving their products or employees time to those communities to help solve real world problems. Salesforce is a great example of this type of company that is loved by ESG investors. Salesforce chief executive officer Marc Benioff is a staunch believer if making sure the company and its employees invest the time needed to support the communities that the business serves.
Summary
ESG investing is a great way to make sure your investment dollars are not being used only to maximize profits.
ESG investors demand that businesses be successful financially, but also do something to make the world a better place.
You can get started with ESG investing by either using a mutual fund, or by creating your own criteria and investing in individual stocks that are in line with your criteria.
Use the examples that we included in this article to get you started with this type of investing.
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