Beyond the bottom line: The ESG Effect

Many CWM clients have expressed interest in choosing – or avoiding – certain investment vehicles depending on their impact on the environment or society as a whole. Those preferences, encompassed under the term ESG investing, are one of many factors we consider as we make investment decisions.

ESG stands for Environmental, Social, and Governance, and the concept proposes that investors can make a return on their investments while also supporting the issues or helping to address the challenges that matter to them. ESG-focused investors look at a company’s environmental impact, its involvement in social issues, and how the company itself is run, with the goal of rewarding and elevating companies that promote positive changes in the wider world.

Here’s a closer look at the subsets of this broad category:

Environmental. Companies that fall into this category are either proactively working to preserve the environment or making a limited negative impact on the environment.

Social. How do companies strive for a good social impact? This covers everything from diversity in the workplace to customer satisfaction to how it responds to internal labor disputes, amongst other social and political trends.

Governance. This concept refers to the leadership of the company itself. How does a company’s board and management drive positive change? How diverse (in terms of concentration of decision-making power and varied perspectives) is the board? How does leadership interact with shareholders and employees? Each of these questions relate to governance.

Use a critical eye

As you can see, ESG is composed of somewhat nebulous categories. A good parallel for ESG are the labels “natural” vs. “organic” on food and consumer products. “Organic” is a designation that’s strictly regulated, and only products that meet USDA standards for ingredients and production can legally use the “organic” label. On the other hand, “natural” is largely used for marketing. Many foods and products with “natural” on the label really do hold up to scrutiny, but there are no legal or regulatory consequences for those that don’t.

Because ESG is not a regulated designation, the term is more synonymous with “natural” than it is to “organic.” Not every investment option that touts its ESG credibility will hold up to that scrutiny or truly promote environmental and social good. For example, social media and tech companies usually have high ESG investing scores because they have little to no direct environmental impact compared to that of oil explorers and producers. But the argument could be made that social media giants like Meta fall short by creating platforms that feed political division and other negative societal challenges.

So how can you tell the substantive ESG investments from the hype? You’ve got to dive into the data. CWM uses an independent research and analytics firm called Sustainalytics to inform our ESG choices. Sustainalytics monitors more than 700,000 news items each day and provides ESG data, analytics, and reports on more than 20,000 companies worldwide to create a scoring mechanism. Lower scores are better, and CWM portfolios seek to have a favorable rating versus the overall stock market as represented by the S&P 500 stock index.

Weighing the options

It’s important to note that at CWM, ESG is just one of 17 factors that we take into account when making decisions about our clients’ investments. Real returns are always the focus, and our primary goal is always to target the return that will help support our clients’ financial plan. But if we can achieve that outcome while also contributing to social and/or environmental good, then that’s even better. As you can see in the illustration above, CWM’s investment models currently lean toward the friendlier end of the ESG spectrum vs. the S&P. CWM’s portfolio has an average ESG score of 22.89, compared with the S&P, which scores a 25.

As a society we are still early in the game when it comes to developing green sustainable products, technologies, and organizational structures. It is through a partnership of corporate stewardship and consumer responsibility/demand that we will continue to move forward in the right direction.

If this subject is interesting to you, one resource you might check out is the book Conscious Capitalism: Liberating the Heroic Spirit of Business, by John Mackey and Rajendra Sisodia. Conscious Capitalism promotes a business culture that embodies “trust, accountability, caring, transparency, integrity, loyalty and egalitarianism.” This topic is gaining a lot of traction, and we’re glad to see these conversations happening with more frequency and depth.

To learn more about ESG investing and how we make conscientious decisions with your investments, give us a call or reach out online. We’re always happy to help at Comprehensive Wealth Management!

***Disclosures: The returns on a portfolio consisting primarily of Environmental, Social and Governance (ESG) aware investments may be lower or higher than a portfolio that is more diversified or where decisions are based solely on investment considerations. Because ESG criteria exclude some investments, investors may not be able to take advantage of the same opportunities or market trends as investors that do not use such criteria.