If you've heard about ESG investment
you know that it refers to companies
that focus on environmental, social, and governance issues.
What we'll talk about today is how
it is fundamentally changing the investment landscape.
There are a variety of motivations
behind the ESG movement.
While some investors want their money to go towards companies
and projects that will change the world,
others simply want to minimise the harm that their investments
have on communities and ecosystems.
Then there is a third group who are looking
to use ESG principles to protect their own portfolio
from potentially negative impacts.
But no matter the motivation, all ESG investors
want to make a return on their money.
If it sounds straightforward, just know that this is much
harder in practise than in principle.
For example, how do you decide whether a company deserves
the halo of being classified as ESG-friendly?
Take Tesla.
The company makes electric cars which
are better for the environment than traditional ones.
So you would think this investment
would have a positive effect on the environment
- but not so fast.
Hey, everyone.
There are questions around the environmental impact
of mining nickel, which Tesla uses in its batteries
and is the electricity used to charge
a car coming from renewable or non-renewable sources.
Tesla has also announced that it made a $1.5bn investment
in Bitcoin.
And as has been pointed out by Bill Gates,
mining Bitcoin is an environmentally-damaging
activity because of the energy it requires.
So what do you do if you want to invest
in environmental progress?
Do you buy Tesla shares or not?
The answer is not so clear cut.
These days most people don't have to make that decision.
A rise in passive investing means
that most folks choose an index-tracking fund,
like an ETF or a mutual fund, which
puts their money into a basket of company stocks
that track an index.
To create an ESG-focused index simply
means that the companies in that basket
have met certain criteria that make them ESG-friendly.
But what does that mean in reality?
Well it's still up for debate.
Nonetheless, the sheer number of indices
that provide an ESG focus have exploded from 2019 to 2020,
increasing by 40 per cent, according to the Index Industry
Association survey.
The amount of money going into ESG assets has also exploded.
In the US in 2016 there was $8.1tn
in professionally-managed ESG assets,
according to the Forum for Sustainable and Responsible
Investment.
By 2020 that number grew to $17.1tn,
which is more than a 100 per cent increase in just four
years.
And as for figuring out which companies to put in those
indices we talked about, many index providers
rely on various metrics that score companies
based on their ESG impact.
Examples of metrics are things like exposure
to carbon-intensive operations, energy efficiency, human rights
concerns, et cetera.
However, there can be discrepancies
between the ratings agencies, even when they're
scoring the exact same company.
Often, index providers will have a committee
that helps make decisions on which companies to include
and which to exclude.
This is important because the company stocks they include
will benefit from more investor cash.
But the subjectivity of classification
has led to controversy over whether some funds are truly
investing in companies that fulfil the vision of ESG
or whether some index providers are merely
using it as a marketing term and putting the ESG label on funds
that don't really merit it.
This is why it's so important for investors
to carefully read the methodology and perspectives
behind an ESG index before they invest
to ensure that they are getting something that truly reflects
their goals.
So a question you may be asking right now
is whether the returns of those ESG funds
are better or worse than traditional investments.
In this chart showing the performance
of an ESG fund versus a standard fund,
you'll see that they perform pretty much in parallel
to one another.
This is just one example, of course.
Some ESG funds may do better than the benchmarks.
Others may do worse.
But the beauty of ESG is that, in general, investors
don't need to worry about sacrificing performance
for doing good.
Perhaps, that is why we see so much money
jumping on the ESG bandwagon.