Last Modified on October 26, 2020

ESG stands for environmental, social, and governance. As the name suggests, ESG investing offers investors the opportunity to invest in companies that follow the principles of ethical work practices, environmental-friendly operations, and socially responsible products. Most funds are evaluated based on their financial value. However, in the case of ESG funds, factors such as safe and fair workplaces, green practices, and an overall ethical code of conduct are given precedence. Hence, companies that produce or manufacture products like tobacco, arms and ammunition, alcohol, etc. do not find a place in ESG investing, regardless of how profitable they may seem at a given time.

If you are thinking of investing sustainably, here are 5 things that you should know before you invest in ESG funds:

1. ESG funds are good for the planet

The news of the planet approaching a slow death has been the talk of the 21^st century. Development has eased lives, but it has also caused massive damage to the environment. Directly or indirectly, common investors too have contributed to this problem by investing their money in companies that negatively impact the planet. When you invest in the stock of a company, you become a participant in its growth. If this company indulges in practices that harm the Earth, you too, become a part of this destruction. The same can be said for companies that follow unfair workplace protocols, such as low wages, long work hours, lack of gender equality, ethnic, and sexual diversity, etc. However, there are organizations that are working towards the betterment of society at large. When you invest in funds from these enterprises, you promote their growth. The basic principle of ESG investing is to protect the planet and people and safeguard its future.

2. ESG funds are as profitable as other investments

The common myth surrounding ESG funds is that they are like charity. Many people believe that ESG investing is only limited to the rich and wealthy who may feel the need to give back to society. However, ESG funds are like any other investment where the focus on returns is as high as it is on sustainable investments. In fact, nine ESG funds had outdone the Standard & Poor’s 500 Index in 2019. Seven of these funds had also performed better than the market benchmarks of the last five years. The growing numbers are a clear indication of how these funds are no more only reserved as a way to pay back the planet. Instead, they are great products that offer high returns and can suit any investor and find a place in their portfolio.

3. ESG funds may be the future of investing

The current generation of youngsters and the ones to follow are greatly involved in sustainability. Over the last decade, many green businesses have come up. Products like vegan soaps, cosmetics, recycled clothes, etc. and businesses empowering minority communities, artisans, women, etc. have found a place in the mainstream. While the baby boomers focused only on development and progress, the youth of today is also worried about the downturns of this growth. This brings ESG funds right on the top. Their popularity has increased manifold in the last couple of years. This has also encouraged companies to adopt ethical practices. ESG funds outperforming the S&P 500 Index is a clear indication of where this spectrum of investing is headed.

4. There are no ESG standards yet

While ESG investing is gaining popularity, investors still continue to face some issues. One of these is that there are still no ESG standards to measure growth and allow estimations. This makes ESG funds a bit trickier than other types of investing.  ESG investing may also seem difficult to investors as well as some financial advisors, as they have to rely on their own assessment of funds and past data. Moreover, many businesses do not report and release information on their internal policies, for instance, gender equality, ethnic diversity, carbon emissions emitted in a year, sexual diversity, etc. at the workplace. So, there may be more viable ESG companies than you know of or can find to invest in. The lack of a set standard has had a considerable impact on ESG funds. Until there is a fixed standard for these companies, the process will likely require more research and time from investors and financial advisors.

5. ESG funds may lack diversification

The importance of diversification in investment cannot be stressed upon enough. Optimal diversification can lower the overall risk from your portfolio and offer you better returns and opportunities for profit. However, diversification and ESG funds may not always go hand in hand. ESG companies are generally limited to large-cap stocks. Hence, you lose out on the opportunity to invest in small-cap and mid-cap stocks. Moreover, ESG companies can be easily outnumbered by other businesses. Hence, it provides you with a smaller selection for choice. ESG investing also excludes many industries, such as arms, ammunition, alcohol, tobacco, etc. and is limited to industries such as hydro energy, recycled products manufacturing, solar energy, etc. This reduces the opportunity to diversify across industries and sectors. So, in case of a market downturn, you are exposed to more risk.

To sum it up

ESG funds do come with some drawbacks, but that is primarily due to the novelty factor attached to them. As time passes and there is more data available, investing in socially responsible companies and stocks will not only get easier but also more popular. There are many benefits of investing in ESG funds, and it offers you the peace of mind and a do-good factor that you are contributing to enhancing and bettering the world.

To know more about ESG funds and how you can invest in them, you can get in touch with financial advisors.