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The Basics of ESG Investing

Insights Investing Stock Market

ESG Investing is becoming a more popular topic.  The "E" stands for environment, "S" represents social, and "G" stands for government.  It is a newer trend in the investment world and we are hearing more questions from clients.  We'll explain what it means, how you can use this investing criteria, and some potential issues you might encounter.

Watch now: The Basics of ESG Investing

  • 0:00 Intro and Disclaimer
  • 0:37  The "E", "S", and "G" of ESG investing.
  • 2:16  How do we know what companies fit this description
  • 4:17  Some of the investments may not be what you think
  • 6:35 The "E" gets the most attention
  • 8:15 There are always trade-offs
  • 10:51  Final Thoughts
  • 13:33 Outro

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The "E", "S", and "G"

This type of investing methodology focuses on three things:  Environment, Social, and Governance.  Here are some examples:

E = Environment

Air and Water Pollution
Energy efficiency
Waste Management
Water Scarcity

S = Social

Customer Satisfaction
Data protection and privacy
Employee engagement
Community relations
Human rights
Labor standards

G = Governance

Board composition
Audit Committee Structure
Bribery and Corruption
Executive Compensation
Political contributions
Whistle blowing

How do you Know What Companies Fit the ESG profile?

In general, the primary source for ESG ratings comes from MSCI.  MSCI rates 8,500 companies all over the world.  There are other firms who produce similar ratings as well. From this list, investment managers then use these rankings to build portfolios.  Some of these are easily purchased as a mutual fund or exchange traded fund (ETF). Individual investors can also use the ratings as part of their screening process to select specific investments.

Know What You're Holding

Not every ESG-focused investment may be what you think it is.  Some investments are constructed based on the total overall ESG score.  So you may find companies like Haliburton, Baker Hughes, and Kinder Morgan as part of the holdings.  All of those are energy companies.  In addition, some of the holdings may also include Deere and Caterpillar.  The final products from those two consume a lot of diesel fuel. 

Some ESG-focused investments are exclusionary or filter for a specific element.  Some funds will exclude fossil fuel investments.  Others will focus on companies with a higher diversity score.   These types of investments may help you align your investments more with your values and desire to make an impact. 

The "E" gets the attention

The environmental side of ESG tends to get the most attention.  There are more choices to build your filters for environmental concerns.  It can be more difficult to find investments focused on other social or corporate governance issues.  

If you are an investor who is focused on this screening method, you need to determine what is important.  Are you looking to exclude certain types of companies? Are you looking for a more broad-based selection where the total score matters more?  Or, is your total return and achieving your financial goals more important?

The Future of ESG investing - Direct Indexing

Many custodians are beginning to introduce the ability to buy fractional shares of individual stocks.  When you combine this with leading technology, it makes building custom indexes possible.  This way if you want to build an index that excludes oil companies, you can.  Likewise, if you want to build one that excludes wind and solar, you can do that, too.  

One thing to keep in mind about this.  This will likely come at an additional cost to investors.  The custodians charge more, and the time it will take to construct and manage that portfolio will also drive management fees higher.  But if you desire a higher level of customization, you will be able to find that in the near future.

Have Questions about ESG?

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Appearing in this video...

Nikki Lude, cFP®

Nikki is a Certified Financial Planner­­­­™ Professional located in Woodsfield, Ohio.  She begins her 20th year as a financial planner.

Tyler Szafran, RICP®

Tyler is a financial consultant in our Wheeling, WV office.  He has been with Commonwealth for almost 2 years.

Neal Watson, CFP®

Neal is a CFP® Pro in Marietta, Ohio.  He has been a financial advisor for more than 26 years.