Broker Check

Is ESG Investing Ready for Prime Time?

June 12, 2023

Environmental, Social and Governance (ESG) investing has become a hot button topic recently. ESG has become the new catchphrase for initiatives that show sustainability, climate consciousness, equality, inclusion, and equity. It can focus on how the employees are treated or the diversity present on an executive board, or other factors that are difficult to define. These factors can be quantified with an ESG score, and companies can share those scores in the hope of drawing more investors.

Are ESG practices genuinely improving sustainability and equality?

The ability to promote a strong ESG score seems beneficial for all, but many of these initiatives are difficult to measure and companies can often participate in "Greenwashing" (think whitewashing but green) where the company is making small changes to appear to increase the ESG score for their benefit. Because so many of these measures are subjective, it can be easy for companies to make some moves to appear to be more compliant with accepted ESG practices, when in reality they are not, similar to the memes that popped up about a certain beer giant spending millions and millions of dollars to advertise that they had donated thousands of dollars’ worth of water to communities in need.

So ESG initiatives improve the bottom line for a company, making wise investments?

While an ESG investment may be socially responsible, it isn't always fiscally responsible. The hope for the companies is that ESG initiatives will improve the bottom line as customers choose them over the competition because they “care”. However, some initiatives are very expensive or impractical. In the short run, they may actually hurt the bottom line for a company. For example, a large corporation outfitting all of its buildings with LED lighting and solar panels. When they spend $1 billion on this initiative it means that there is $1B less profit in the short term. Furthermore, how long does it take for the company to reap financial benefits from this investment? It could be years before they recoup their investment in the energy bill savings. Will it provide a return in the long run or is simply an expenditure to look good?

While the intention of increasing diversity in the workforce is to prevent discriminatory hiring and promotion practices is obviously well intentioned, the implementation may result in hiring people based on characteristics other than their actual qualifications for the job. In the best-case scenario, you may find the best person for the job in whatever desirable characteristics of diversity are trending at the moment, but that’s hard to say for sure. Focusing on diversity means many corporations now have Diversity, Equity, and Inclusion (DEI) officers whose only purpose is to regulate the diversity and inclusivity within a company. Their departmental costs including salaries, benefits and such also add to company costs.

Bottom Line: Is ESG a good investment?

Anyone who has watched the billions of dollars lost from Budweiser and Target in the last few weeks knows that is a very loaded question. If a company wants to take on a public ESG strategy, they better make sure it aligns with the values of their core customer base. Otherwise, they stand to have their strategies backfire and face substantial losses. Bud Light has been buying back cases of beer from distributors who could no longer sell the product. When the company backtracked and said they made a mistake in having a transgender spokesperson for their brand, they then alienated the smaller but significant new customer base and thus lost support from people on both sides of the campaign.

There may be countless other issues that you find that speak to you either for or against ESG initiatives and it’s something you want to consider in your investment strategy as well.

None of this means ESG is necessarily bad. Its increasing popularity just means that investors are looking for ways to align their investments with their values. A 2021 report by the Global Sustainable Investment Alliance reported that ESG assets under management reached $35.3 trillion, up from $22.9 trillion in 2016. The difficulty is that ESG factors can be subjective and difficult to measure. There is no single standard for ESG reporting, which makes it difficult to compare companies. Another challenge is that ESG investing can be more expensive than traditional investing. ESG funds often have higher fees than non-ESG funds. Additionally, what meets your values will be different from someone else. One person might be against abortion, but fine with tobacco products whereas another might not like either. Some might choose a particular value that is important to them and do not want to support a company that is involved directly or indirectly with violating that value. Others might recognize that even though a company might not support their particular value, as long as that company isn’t directly engaging in those activities, they are ok with it. What answer is right for you?

The more strictly you want your investments to align with your values, the more companies you eliminate. Keep in mind that eliminating a significant number of possibilities may compromise the return on your investments. The stakes may be worth it for some, and others may find that they increase profitability while feeling more comfortable with the ethics of their strategies. Interestingly some people are investing in companies that do things they don’t agree with, because it gives them an opportunity to vote their shares against that practice. That could be another way to affect change.

At Red Barn Financial, we serve our clients by using a software that has a screening process to analyze what is important to you and helps you make an educated decision on which companies you want to invest in and how much you want the ethics to factor into your decision. From there we can make a custom portfolio that meets your values. I specifically do this from a faith-based perspective. If that’s something you want to take a look at, feel free to reach out and I’d be happy to help you with the analysis.