Although we are already nearly halfway through 2021, the critical issues that 2020 exposed remain at the forefront of many people’s minds. From social justice protests to the economic crisis and an augmented focus on climate change, many people are increasingly searching for ways to enact change in more areas of their lives. With more Americans receiving the COVID-19 vaccine, people are also contemplating what comes next. However, the concept of going back to “normal” is increasingly being met with the realization that our future reality does not have to mirror the past. We have witnessed different methods of attempting to shape the future, from mass demonstrations to social media activism. In the financial realm, three letters have dominated: ESG. Increasingly people are realizing that they can be a part of shaping the future by how they invest.
What is ESG?
Environmental, social and governance (ESG) investors analyze criteria within these three buckets to determine an investment’s potential financial return, risk and its overall impact. ESG criteria could include racial and gender diversity, environmental sustainability, executive compensation, and labor and employment practices, among others. Beyond the benefits of creating a more ethical portfolio, there is evidence that ESG investments carry less risk and deliver similar returns as traditional investments. Many helpful resources exist on ESG and sustainable investing, such as US SIF: The Forum for Sustainable and Responsible Investment’s (US SIF) Sustainable Investing Basics page.
Despite the growing importance and popularity of ESG investing, it is still a relatively new player in the world of finance. Most conversations we see in the media revolve around the basic question, “What is ESG?” While it’s important to introduce interested investors to the basics, we’d like to dive into some of the less discussed aspects of ESG, as well as highlight a few buzzwords and trends that financial services firms and investors should know.
Putting community at the forefront
Community development financial institutions (CDFIs) lend to businesses and nonprofit organizations that may not be served by traditional financial institutions like banks or credit unions. As the name suggests, CDFIs work toward community development through lending programs to small businesses or non-profits and serve a crucial role in supporting underserved communities.
Known as the “first responders” of the COVID-19 pandemic, CDFIs have been the financial lifeline of many communities who were hit hard by the economic fallout of the global health crisis. For example, when the Paycheck Protection Program (PPP) rolled out last March, CDFIs worked to secure $10 billion in funding with the goal of reaching small, minority- and women-owned business in low-wealth markets. Though CDFIs receive most of their funding from banks or institutional investors, individual investors can participate by putting money into community development loan funds.
Using your power as a stockholder
A commonly heard phrase in the ESG conversation is Shareholder Advocacy. Buying stock or equity in a publicly traded company means you own a slice of that company. Ownership gives you the ability to have a voice in company decisions. Shareholders can leverage the power of stock ownership to promote environmental, social, and governance change. Individuals can also purchase mutual fund shares from investment companies that engage in shareholder advocacy.
Shareholder advocacy can take many forms, including proxy voting and company engagement. In recent years, investors have led shareholder resolutions targeting workplace discrimination, greenhouse gas emissions, and corporate political spending and lobbying. US SIF reports that investors filed over 750 resolutions relating to ESG issues for the 2020 proxy season. This article by Debbie Carlson in MarketWatch outlines the interesting debate taking place in the industry on divestment vs. advocacy.
It’s not easy being green, but it is easy to greenwash…
As public interest in ESG investing grows, increasing numbers of fund companies are offering socially responsible investment opportunities. However, these new offerings are not always as green as they seem, and investors are becoming wary of greenwashing. Greenwashing occurs when a company falsely presents a sustainable or ESG investment approach without disclosing any detail on what ESG factors they consider or sustainable investment approaches they are undertaking. A company may present its fund as sustainable when, in reality, it’s “light touch” and abides by weak ESG criteria. Investors hoping their money is going to a fund that will drive positive change might be let down to learn their investments are not as green as initially believed. Taking steps such as researching funds’ true ESG focus by examining a fund’s actual holdings using resources like Morningstar or As You Sow’s screening tool can help investors weed out companies just using ESG as a marketing strategy.
Verifying the true meaning of sustainability pledges
The language used to describe a company’s ESG goals can also reflect the validity of their efforts to mitigate climate change. The terms carbon-neutral and carbon-zero are often used interchangeably, but they have quite different meanings. Companies that aim to reach carbon neutrality, or net-zero carbon emissions, are trying to achieve a balance between the greenhouse gases they emit and the greenhouse gases they take out of the atmosphere. However, achieving carbon-zero emissions means a company’s production never adds new greenhouse gases into the atmosphere. It’s an important distinction to make, especially since organizations have a history of under delivering on carbon offset promises.
Takeaways for communicators
As more individuals turn to ESG investing as a way to enact change with their dollars, transparency is key. For example, to avoid accusations of greenwashing, it is important for fund sponsors new to ESG to describe the ESG criteria they consider, share details describing why they believe their holdings are sustainable and demonstrate their legit ESG credentials. For firms who engage in shareholder advocacy and other methods of seeking to bring about positive change at companies that some would otherwise avoid, clear communication is important. Openly demonstrating the impact of the work so investors understand how it fits into their investing goals can help avoid misunderstandings and pushback.
Finally, it is important to look beyond the basic definition. By paying attention to the more nuanced trends, and communicating them to their clients, financial services firms can meet the diverse needs and goals of their multifaceted customer bases.