What is Sustainable/ESG Investing, and How It Differs from “Socially Responsible Investing” of the Past

What is ESG Investing?“Sustainable Investing aims to identify companies that offer potential for strong financial returns while also demonstrating a commitment to sustainable business practices and positive impact. Sustainability is typically evaluated through analysis of environmental, social, and governance (ESG) policies, practices, and performance.”
* Excerpt, Putnam Investments, “What is sustainable investing?” 

Decades ago, I lived in a lovely New England seaside town where there was a street-level storefront touting a novel idea called “Socially Responsible Investing.” On occasion, while strolling around town with a few of my friends in the financial field, they would throw sarcastic shade at the concept: “Sure, be socially responsible while being financially irresponsible!”

To a degree, their negativity was warranted because the sole criterion in socially responsible investing of the day was assessing how a company would impact the environment and global population, with little regard for corporate governance, good corporate citizenship, or the prospects for consistent returns.

The New Era of ESG (Environmental-Social-Governance)

Fast forward to present day “Sustainable” or “ESG” Investing, also referred to as “Impact” Investing, a values-based approach that has evolved to include:

  1. Sophisticated sustainability and performance criteria and data;
  2. Hundreds of custom-indexed, broad, and niche ETFs and mutual funds to customize allocations for an investor’s personal views; and
  3. Many prominent medium- and large-cap corporations that qualify as ESG assets because they want to be responsible corporate citizens.

The ESG acronym stands for Environmental-Social-Governance, and it covers broad territory:

Criteria for ESG Investing

* Graphic, Morningstar research, “What’s in a Name? The Many Dimensions of Sustainable Investing

The Importance of Good Governance

The Environmental and Social categories are obviously relevant to sustainability but the quality of Governance may have the greatest impact on a company’s ability to deliver on all facets of a responsible sustainable investment. At a recent Barron’s roundtable discussion on ESG Investing, Abby Joseph Cohen of Goldman Sachs said that “Companies that score well on Governance score well on everything else.”

Assessing the quality of Governance can lead to counterintuitive but instructive results. For example, imagine a (fictional) electric vehicle manufacturer, a clear-cut candidate for a high Environmental score. Now factor in a poor Governance scenario with a subpar board of directors, an unpredictable CEO, high debt, dicey cash flow, and bad public relations, all of which reduces the manufacturer’s ESG score to middling or lower. Not exactly what investors would expect for an EV company, and proof that sustainable investing is nothing my friends can poke fun at any longer. An investing approach born of idealism is now largely driven by values-based practicality.

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