Investing with a socially conscious bent is moving into the mainstream and environmental, social and governance strategies are increasingly finding a place in investors’ portfolios. In 2016, ESG investing assets grew to $8.72 trillion in the U.S., an increase of 33 percent since 2014, according to the most recent Report on Sustainable, Responsible and Impact Investing Trends from US SIF.
Anthony Glomski, principal and founder of Los Angeles-based AG Asset Advisory, says that in his experience, one of the highest priorities for investors is aligning their money and values with the causes they care about most.
“One of the benefits of ESG investing is impacting the world positively, beyond just making personal choices. ESG isn’t simply the latest trend in avoiding sin stocks; rather, a new generation has the power to influence the way corporations do business, shape society and influence the environment,” Glomski says.
[See: 7 of the Best Socially Responsible Funds.]
Retooling your asset allocation to include these strategies may sound appealing if doing good is just as important to you as building wealth, but there are certain risks involved. Reviewing all the angles can help you determine whether investing from a social and environmental point of view fits your long-term plans.
Identify what motivates you as an investor. Before dipping your toes in the ESG investing pool, ask yourself what you hope to get out of it.
Karina Funk, co-portfolio manager of the Brown Advisory Sustainable Growth Fund (ticker: BIAWX) says this type of investing offers many benefits, but investors may pursue this path for different reasons.
“We generally find that most investors are looking for some combination of three factors: performance, values alignment and impact,” Funk says. “While investors often begin their journey prioritizing one of these outcomes, they can find ways to effectively achieve all three.”
Funk says investors shouldn’t think of ESG investing as something that fits one particular investing style better than another. Conservative investors, for example, may own green bonds that fund environmentally beneficial projects, while investors who are comfortable assuming more risk can invest in stocks where the management of companies are focused on promoting sustainability.
“ESG doesn’t just have to be about screening out bad actors — you can use it to find great long-term performers as well,” Funk says.
In terms of performance, value and impact, think about what matters to you most. Then, consider which causes you prefer to champion. For example, US SIF data shows that climate change, conflict risk and human rights have been the most prominent drivers of ESG choices since 2014.
If you’re concerned about protecting the environment, encouraging good corporate behavior or supporting fair labor standards on a global level, ESG investments can be a good solution.
Keep risk in perspective. The process of incorporating ESG values into your portfolio affords an opportunity to give back, but you need to consider how that aligns with your risk tolerance.
[See: 7 Socially Responsible ETFs for Investors of All Stripes.]
“Investors need to be aware that this is a new way of investing, so there isn’t a reliable way to track risk,” says Robert Baltzell, president of RLB Financial in Los Angeles. “The lack of benchmarks makes this type of portfolio difficult to evaluate and determine if it’s good or bad.”
Robert Morier, managing director and head of North America at Global Evolution in New York, says ESG strategies may yield some benefits in terms of managing risk.
“Accounting for ESG factors in investment decisions mitigates risk because they allow us to look ahead whereas traditional financial metrics tell a story that’s already happened,” Morier says. “A misconception exists that it’s hard to quantify ESG issues such as political stability or access to health care, but ESG issues are economic factors and therefore quantifiable.”
In terms of performance, that may work to the advantage of investors.
“We see a clear link between improving ESG dynamics and investment returns, specifically in emerging and frontier market sovereign bonds,” Morier says. “While traditional business practices may perpetuate the idea that an organization must choose between doing good and making money, ESG investments don’t carry the weight of that trade-off, as the intention is to do both.”
Anthony Eames, director of responsible investing strategy at Calvert Investments in Boston, says the way companies that observe ESG practices manage risk internally can also be advantageous for investors seeking strong performance without moving too far out of their comfort zone.
“One of the benefits of investing with ESG investing firms is that they seek to understand how companies are managing the risks and opportunities associated with environmental and social challenges, which are increasingly understood to have financial relevance,” Eames says. “We assess not only how companies have managed these issues previously and how they’re doing now, but also how they’re preparing their businesses for the sustainability challenges of the future.”
Remember that diversification still matters. Adding ESG investments may require you to look at your broader asset allocation to ensure that your portfolio is properly balanced.
“It’s important to diversify every portfolio. The same goes with ESG investments,” Baltzell says.
He advises investors against overexposure to ESG investments if they don’t fully understand the correlation between risk and return. Baltzell recommends limiting them to one-third or one-quarter of your overall portfolio.
Liz Miller, president of Summit Place Financial Advisors in Summit, New Jersey, says that in choosing ESG funds for diversification, it’s helpful for investors to understand how those funds are put together. “Managers invest in a diversified portfolio with sectors or companies selected for positive ESG performance, relative to industry peers,” she says. “This approach usually avoids companies or sectors that don’t meet certain ESG performance targets.”
Miller says positive ESG investing initiatives usually offer fully diversified portfolios as a core part of an overall portfolio. She cautions, however, that it may not be appropriate for everyone.
“More investors are beginning to understand that the ways we spend and invest can influence the fabric and consciousness of society,” Miller says. “Although we know millennials are looking for ways to achieve their social impact goals, not everyone needs to incorporate an ESG allocation in their investment portfolio.”
Funk says a slow and steady approach may win the race.
[See: 7 of the Best Stocks to Buy for 2017.]
“We try to emphasize with our clients that it’s perfectly acceptable and perhaps wise to start slowly at first. If you don’t own any ESG investments today, you don’t need to replace your entire portfolio,” Funk says. “You can begin with a single mutual fund, carefully consider other investments over a period of months or years and take your time with your advisor to refine exactly how you prioritize your values and how you want to apply those values to your investment plan.”
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