Where do the ESG ETFs invest?
ESG stands for environment, social affairs and governance.
E.SG investments can be used by responsible citizens and funds to analyze the companies on the basis of some qualitative aspects that are not included in the financial statements, e.g. B. on the basis of the effects of climate change on the balance sheet. or even business ethics. It is one of the most important investment methods for responsible investing and it is growing in importance.
Increasing research shows that this method can reduce portfolio risk and generate competitive returns. The combination of ESG investing with traditional stock analysis is known as ESG integration.
ESG funds are funds that invest in stocks and bonds of companies after they have been rated on environmental, social and governance factors.
Now let’s examine the three components of ESG investing:
E is for the environment
Environmental criteria examine the elements that demonstrate a company’s impact on the earth in both positive and negative ways.
Decreasing forest cover, increasing global temperature pollution of rivers and air are some of the ways people neglect the environment. This has resulted in erratic rainfall, drought and flooding. The company’s handling of environmental issues is one of the aspects here.
It can include research on-site
· Compliance with government environmental regulations.
· The achievement of the greenhouse gas emission targets by the company.
· Optimal water use and conservation. Eliminate water pollution.
· Land contamination in hazardous waste disposal.
· Conservation of natural resources and treatment of animals.
· Recycling of important resources and the use of renewable energies such as wind and sun.
· Plans and guidelines for the safety and health of the environment.
Nike is a company that meets the ESG environmental criteria. The sustainability report uses the GRI framework, the SASB and the United Nations Sustainable Development Goals (SDGs), which provide valuable information to investors.
S is for social
Social criteria relate to the company’s business relationships.
· Do the company’s suppliers hold the same values as those of the company?
· History of consumer protection issues, consumer friendliness and customer service responsiveness.
· The company donates a percentage of its profits to the local community and encourages its employees to volunteer. As an an example; Employees help out in emergencies in a society like floods.
· Employee pay and perks, training and development.
· Employee health and safety and preventing sexual harassment.
G stands for corporate governance.
Corporate governance refers to being shareholder-friendly, the board of directors and the management. It’s about the integrity and honesty of management. This also applies to creating wealth for investors in the long term.
· Composition of the Board of Directors, including diversity of the Board of Directors.
· Conflict of interest in the election of the Board of Directors.
· Executive compensation and their bonuses and perks.
· Transparency of accounting methods.
· Involve shareholders in voting on important issues. Complete transparency in communication with shareholders.
· When political contributions are made in order to receive favorable treatment.
· History and relationship in the stock market and other regulators.
For example, Boston-based Trillium Asset Management ESG criteria exclude companies exposed to coal mining as well as companies that derive some of their revenue from weapons. It also avoids investing in companies with corporate governance issues and workplace discrimination.
Investment strategies related to ESG investing
· · Socially Responsible Investing
S.Socially responsible investing originated in the 1970s and emphasizes strategies related to sustainable, responsible and effective investing. It has grown in popularity over time because it cares about all stakeholders like employees, customers, distributors, suppliers and the environment, not just the shareholders.
SRI investors use certain filters or criteria to filter out companies that do not meet their value criteria. It could be the weapons supplies, alcohol or the tobacco industry.
· Impact investing
It falls under socially responsible investing. Investors invest their money in companies that have a positive environment and social impact. Some may be satisfied with returns below the market while others may be satisfied with returns that are comparable or even better. An example could be an area like promoting sustainable agriculture, which is good for poor farmers.
Conscious capitalism is a socially responsible economic and political philosophy developed by John Mackey and Raj Sisodia. Proponents believe that companies should act ethically by serving the interests of all stakeholders involved – not just management and shareholders.
The four guiding principles behind conscious capitalism include a higher purpose, stakeholder orientation, conscious leadership, and conscious culture.
So far we’ve seen socially responsible investing exclude companies that don’t meet their criteria in certain aspects, like the defense industry or sin stocks like gambling, alcohol and tobacco. But an uncomfortable company could be a company with high ESG.
For example, a defense company that manufactures missiles and tanks and scores high on environmental sustainability, treatment of employees, and corporate governance can be included in an ESG fund.
However, some other ESG investors can weed out entire industries.
Growth in ESG investments
ESG and SRI are growing very quickly and are gaining ground with financial institutions and everyday investors. According to 2020 the US SIF Foundation Report on sustainable and impact investing trends in the USA, at the end of 2019, $ 17.1 trillion – was managed according to sustainable investment strategies.
This is becoming increasingly popular because millennials tend to crave social responsibility. Baby boomers are expected to pass on around $ 30 trillion to the future generation.
Morgan Stanley’s Sustainable Investing Institute conducted research in 2017 and found that 86% of Millennials are interested in sustainable investments in companies or funds that aim to generate market returns while creating social and environmental impact.
Advantages and disadvantages of ESG investing
· When values are important, socially responsible investing can put money where your mouth is. You go through the conversation. Pick a few socially responsible funds and be at peace.
· These funds hold money from companies that do not behave. This can force companies to form. It’s like punishing them. Nothing in society would change if you didn’t take a stand.
· It rewards companies that do the right things. If you want companies to be accountable, you need to reward them with investments. In the long term, it can act as a catalyst for social change.
· By investing in socially responsible funds that match your values, you will sleep better at night knowing full well that you are doing something right in this world. The happiest feelings will come when the companies make profits and get good returns on their investments.
This will be a win-win situation for both of them.
· When you invest in socially responsible funds, you may have to forego high returns. Ethics becomes more important than performance. When socially responsible investing becomes a primary goal, the financial side of the equation can suffer.
· ESG ratings often exhibit a size variance that gives larger companies, on average, better ESG scores. This does not necessarily mean that larger companies are more environmentally or socially minded.
Today, a large number of investors are investing billions of dollars in socially responsible funds, the ESG funds. These funds select stocks based on a company’s ESG practices along with traditional financial measures.
This has spawned a new family of Exchange Traded Funds (ETFs) that focus on investment criteria for social well-being. Impact investing securities have outperformed the broader market over the past year. The ETFs with the best 1-year trailing returns are FAN, AIA and GRID.
There are 16 impact investing ETFs in the US with an ESG score of 8 out of 10. Impact investing securities, as measured by the S&P 500 ESG index, have the broader markets with a return of 20.4% last year compared to the S&P 500 surpassed total return of 19.7%.
The best-rated mutual funds based on last year’s performance are the First Trust ISE Global Wind Energy Index Fund (FAN), the ishares S & P Asia ETF (AIA) and the First Trust NASDAQ Clean Edge Smart Grid Infrastructure Index Fund (GRID) .
First Trust ISE Global Wind Energy Index Fund
The company has $ 483.6 million under management and tracks the ISE Clean Edge Global Wind Energy Index, an index that provides exposure to the performance of companies primarily active in the wind energy industry. The fund invests in both growth and value stocks in the wind energy sector.
iShares S & P Asia ETF (AIA)
It manages $ 3.1 billion in assets. AIA tracks the S & P Asia 50 Index, which follows the 53 leading companies from China, Hong Kong, South Korea, Singapore and Taiwan. The fund invests in growth and value stocks. The companies that make up the fund include information technology, finance and the communications sector.
First Trust NASDAQ Clean Edge Smart Grid Infrastructure Index Fund (GRID)
It Assets under management are $ 198.2 million and track the NASDAQ OMX Clean Edge Grid infrastructure index, which is intended to measure the performance of the grid and power infrastructure sector. The company is exposed to companies involved in the maintenance and operation of the electricity network, electricity meters and devices, networks, and the storage and management of energy.
In the 1970s, Milton Friedman popularized the Enterprise value Theory which said that the company’s only social responsibility was to maximize shareholder value, that is, to make money for the shareholders who hold the shares.
It is understandable that a lack of profits can lead to poor results for the company, but companies can get into serious trouble if management is only concerned with short-term profit measures.
When this philosophy permeates corporate culture, employees make bad decisions or even illegal deals to keep management happy in the short term. This can open the company to lawsuits or investigations.
If You are passionate about things that are important to you and want to invest in companies that live up to your morals. Then ESG investing is for you. Look for ESG ETFs that match your ambitions and beliefs and if they work, you will find it worth it. We can then rightly say that ESG investing has become an important part of the investment process.