Quarterly Outlook
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Peter Garnry
Chief Investment Strategist
Saxo Group
Summary: Keen to align your financial investments with your ethical values? Discover about the rise of ESG stocks - equities committed to high environmental and societal standards.
Environmental, Social and Governance (ESG) investing is considered one of the most ethical ways to build an investment portfolio. With millennial and Gen Z investors appearing keen to align their values with their financial investments, brokers have tried hard to offer financial products that align with the so-called ‘ESG criteria’.
These criteria have become a set of standards which ethical investors seek to follow.
ESG trading has been around longer than you think. The issue with publicly listed companies and stocks was raised by Milton Friedman in 1970. Friedman coined the term ‘Shareholder Value Theory’, which characterised the behaviours of many listed corporations throughout this era.
Friedman claimed that listed companies had tunnel vision – a one-track goal to optimise financial returns for their shareholders. He believed that this Shareholder Value Theory caused many large companies to adopt a rigid approach to their operations, foregoing their environmental and social responsibilities in favour of chasing a quick buck.
Before Friedman’s theory, the previous decade threatened to usher in a new era of socially responsible investing. Following the Vietnam War, concerns grew for funds for university endowments to cease investments in defence stocks. 20 years later, companies deemed complicit in South Africa’s apartheid system were also given a wide berth by global investors. This alone led to the economic instability in the region, forcing the long-awaited collapse of the apartheid regime.
More recently, ESG screening has become an integral part of modern-day financial analysis, with investors conscious of the wider impact of short-term shareholder value.
If you are new to the concept of financial trading and investing, it's a good idea to familiarise yourself with the ESG criteria. It's a framework used to define the sustainability of an equity, based on a string of environmental, social and governance factors.
Multiple factors comprise the ‘Environmental’ element of the ESG criteria. The most prominent are strategies regarding climate change and energy efficiency. Climate change is an increasingly hot topic around the world. Ambitious targets have been set within the Paris Agreement and the UN Framework Convention on Climate Change. As governments agree on new regulations, this will have a knock-on effect on the supply chains and output of leading companies.
Companies that research and develop new strategies to tackle recycling and waste management, as well as integrating natural resources into everyday operations, will also curry favour with ESG-focused investors. Even traditional sectors such as the light industry may achieve strong ESG scores for overhauling their manufacturing processes and limiting the toxins involved or for improving the carbon footprint of their supply chains.
The ESG criteria is about more than just environmental challenges like cutting CO2 emissions, air pollution and waste management. It looks closely at social factors to determine how corporations treat their staff, as well as the dissatisfaction of their customers. Companies will be reviewed and rated based on the inclusivity of their programs and recruitment practices, taking into account the need for diversity.
The social factors of ESG also take into consideration a company’s standing within its local communities. ESG scores will rate a company’s commitment to advocating social good, far beyond the limits of its own business or industry.
Governance factors carry equal weighting too, with significant emphasis on corporations with a diverse board of directors, as well as those which avoid high-profile lawsuits. Aside from the diversity of a company’s board, it’s the actions of said board that make a difference too. How does the company’s board and senior management commit to driving positive change?
Does the company lobby hard in the best interests of the wider society? Does the firm have strong, trustworthy links with industry regulators? Does the company have a history of maintaining an open, transparent relationship with its shareholders? The answers to these types of questions can help to nail down a company’s ESG score.
As time elapses, pressure is intensifying on companies from all angles to adhere to the ESG framework. Those stocks that demonstrate a commitment to moving with society are more likely to stand the test of time and provide long-term value for investors.
There are four types of ethical investments you can look at add to your portfolio:
A company’s ESG score is a numerical rating of how it is seen to be performing, based on a plethora of environmental, social and governance factors. It’s important to note that these ESG scores are primarily based on publicly available information so if a company has environmental issues that aren’t disclosed and not known in the public domain, it will not be reflected in its ESG score.
There is currently no standardised approach for rating a company based on ESG factors. Multiple rating agencies provide timely assessments of companies’ ESG standing. The largest ESG rating providers are:
We’ve already alluded to the ethical benefits of adding ESG stocks to your investment portfolio, but there are other ways that ESG stocks and indices can influence your bottom line.
The rising interest in ESG stocks brings with it a string of challenges for ESG-focused investors. In such a fast-paced world, there are many roadblocks for investors to negotiate to make ESG stocks a positive addition to your long-term investment portfolio:
By checking stocks and funds’ ESG ratings, it’s easier than you think to build your diversified portfolio with a strong ESG profile. With more ESG-friendly stocks, mutual funds, ETFs and index funds available to trade than ever before, it’s possible to build an ESG-focused portfolio.
Alternatively, if you don’t wish to be self-directed, you could take advantage of our managed portfolios offering.
For example, the Brown Advisory Ethical Selection is a managed portfolio that focuses squarely on buying strong ESG stocks listed on the US stock markets. As with many of our managed portfolios, there is a minimum investment required to get started. However, there is no minimum investment period with any of our managed portfolios. You can exit the portfolio at any time without paying a penny. Nevertheless, you should remember these portfolios are designed with long-term investments firmly in mind and are best suited to those willing to let their funds grow over several years.
If you’re someone that likes the idea of investing in sustainable and forward-thinking companies that are in total alignment with your moral compass, the first step is opening a brokerage account.
At Saxo, our Saxo Account gives you immediate access to over 40,000 instruments, including thousands of ESG-friendly stocks and funds including mutual funds, ETFs and managed portfolios.