How to Invest in ESG Like a Pro

Despite its growing popularity, there’s a lot of confusion around ESG investing.

Whether you’re just getting started or you’re looking for a little perspective, this quick guide is designed to help you cut through the noise and make sense of what ESG investing is and what it isn’t.

ESG, short for environmental, social, and governance, is an umbrella term for the frameworks investors and companies use to measure and invest in the non-financial impacts of a business. Supporters of this approach still value financial returns, businesses and investors who focus on ESG use a broader set of metrics to judge a company's value. Looking beyond a company’s shareholders, this form of stakeholder capitalism, as it’s sometimes called, works to think more proactively about a business’s role in society. While many believe ESG investments can help companies be more competitive, investors and businesses use it as a way to align their investment goals with their ethics and values.

At a basic level, ESG analysts and managers produce important data and analyses to help companies be more transparent about their impact on society. These reports and analytics can shed a revealing light on a company’s priorities and practices. Ultimately, this helps investors make more informed decisions while giving governments access to the information they need for effective oversight and policy. 

Despite all of its promises, the field of ESG investing and its role in the economy still has a lot of room to grow. 

For starters, measuring something intangible is actually very hard. While many ratings agencies, consultancies, and analytics firms are beginning to fill the gap, the field of quantifying things like employee welfare, sustainability, and good governance is still very young. With no methods for standardization and oversight, ESG reports create opportunities for marketing spin and financial fraud. Currently, US companies aren’t even required to report on ESG.

• Blackrock’s former sustainable investing chief now thinks ESG is a ‘dangerous placebo’ - CNBC
• CEOs are calling for more regulation—of ESG standards - Fortune
• ESG Standards Could Converge Within the Next Two Years - Yahoo Finance

ESG can also be very subjective. While there are some things we can all agree on, the field of stakeholder capitalism touches on topics of politics and ethics, which have different meanings for different people. This does more damage to the standardization and scalability of ESG. Businesses are wary to adopt values that align with one group of consumers while alienating another.

Companies and investors also struggle to export ESG investment strategies to markets where laws and cultures are different from their own. Do American companies have a responsibility to promote American values when working in China, or should they adapt their approach to ESG in response to local demands? Principles of accounting and finance are generally the same across cultures. Politics and ethics are not.

Even in the US, there’s plenty of competing views about the role of business and capital in society. Not everyone has the same vision of stakeholder capitalism. While some believe in expanding the charter of a corporation’s duties through ESG, many believe a company’s highest priority should always be shareholder profits. Both sides believe in some sort of balance between the two, but there’s a lot of disagreement over where to draw the line.

•  The political CEO - The Economist 
• Don’t believe the cynics: Done right, stakeholder capitalism is what America needs - Fortune 
• We Are Nowhere Near Stakeholder Capitalism - Harvard Business Review

That’s also in part because ESG investments don't always produce clear financial benefits. While many studies have shown a strong correlation between ESG investments and financial returns, the lack of good ESG data means that many are still skeptical. Despite its growing popularity, the amount of American capital in ESG driven funds lags far behind Europe. 

• Why ESG Investors Are Happy to Settle for Lower Returns - Wharton Business School 
• Majority of ESG funds outperform wider market over 10 years - Financial Times
• Two years after the Business Roundtable statement on stakeholder capitalism, has anything changed? - Fortune 

Even though so much of the industry's future is up for debate, that debate and the industry's development are two things investors can count on throughout the long term. Regardless of their own opinions, those who understand ESG's value and its impact on markets will be in a better position to capture opportunities.