ESG investing involves investing in companies or funds based on how well they perform on environmental, social and corporate governance measures. ESG investing has grown in popularity in recent years due to the influence of factors such as climate change and social justice on investors, according to the CFA Institute.
The practice began in the 1960s and has gained traction in the investing world since.
Here’s what each area of ESG means:
- Environmental – Companies that score well in this area may focus on a specific industry such as renewable energy or be particularly focused on limiting their environmental footprint in general. They may take steps to limit their carbon emissions or use natural resources in a responsible manner.
- Social – Companies that measure well on social issues focus on racial and gender diversity in their hiring practices and treat employees fairly when it comes to workplace environment and compensation.
- Governance – Companies with strong corporate governance organize the business in a way that is fair to shareholders and other stakeholders. Executive compensation is tied to shareholder-friendly metrics and the board of directors is organized in a way that allows it to do its job independent of a company’s management team.
Companies that operate their businesses based on the principles of ESG may or may not be good long-term investments. But many investors are increasingly focused on the impact of their investments beyond just profits. Investors interested in ESG investing can choose to buy stocks of individual companies or invest in exchange-traded funds, or ETFs, that invest based on ESG measures.
ESG investing statistics
- 88 percent of public companies have ESG initiatives in place, according to a December 2020 survey from NAVEX Global, a compliance software company.
- About two-thirds of privately-owned companies have ESG initiatives in place, according to the NAVEX survey.
- 89 percent of investors consider ESG issues in some form as part of their investment approach, according to a 2022 study by asset management firm Capital Group.
- 31 percent of European investors say ESG is central to their investment approach, compared with 18 percent of investors in North America, Capital Group found.
- Just 13 percent of global investors see ESG as a “passing fad that will eventually go out of fashion,” according to Capital Group.
- Bank of America, NVIDIA and Microsoft took the top 3 spots in nonprofit research organization JUST Capital’s 2023 rankings based on ESG metrics.
Popularity growth in ESG investing
Interest in ESG investing has been on the rise in recent years as more investors prioritize the impact of how their money is invested. Global ESG fund assets reached about $2.5 trillion at the end of 2022, up from $2.24 trillion at the end of the third quarter, according to Morningstar. The nearly 12 percent jump in assets was almost double the growth of the broader global fund market.
However, the growth has been overwhelmingly driven by Europe, with the region accounting for 83 percent of ESG fund assets at the end of 2022 and seeing positive inflows of $40 billion during the fourth quarter. The U.S., which accounts for 11 percent of ESG fund assets, saw outflows of $6.2 billion during the final quarter of 2022. The 2022 outflows in the U.S. followed a long stretch of positive growth for ESG funds.
Global investors are increasingly focused on ESG issues in their investment strategies. Roughly 89 percent of investors considered ESG issues in some form as part of their investment approach in 2022, up from 84 percent in 2021, according to a Capital Group study. The growth is largely being driven by clients and reputational concerns rather than deeply held beliefs by the investors, the study found.
Global ESG investing
The vast majority of ESG fund assets are held in Europe, where sustainable funds account for 20 percent of overall fund assets, according to Morningstar. That number is expected to increase further as new funds are launched to capitalize on investor interest in ESG investment management.
While the U.S. ranks second to Europe in ESG fund assets, there remains a large amount of skepticism in North America about the viability of ESG investment strategies. About 61 percent of investors in North America said asset managers predominantly use ESG as a marketing tool to sell products and enhance their reputations, up from 57 percent in 2021, according to the Capital Group. In Europe, just 6 percent of investors say they’re yet to be convinced about ESG investing, compared with 20 percent of investors in North America.
ESG adoption challenges
| ESG adoption hurdle | % of North American investors who agree |
|---|---|
| Lack of robust ESG data | 46 percent |
| Performance concerns | 49 percent |
| Greenwashing concerns | 37 percent |
| Complex regulatory landscape | 16 percent |
| Lack of suitable products/strategies | 21 percent |
| Focus on short-term investment horizons | 15 percent |
Source: Capital Group ESG Global Study 2022
When it comes to adopting ESG as part of the investment process, North American investors are most concerned about the impact it will have on investment performance. Roughly half of investors cited performance concerns as a hurdle to adopting ESG as part of their investment strategy. About 46 percent said the lack of robust ESG data presents a major challenge.
Research providers offer ESG scores on both funds and companies to aid investors in their decision making. The scores are calculated based on various ESG metrics such as carbon emissions, raw material sourcing, labor management and tax transparency. The scores can then be used to compare companies within the same industry or in the overall corporate world. As companies change their businesses to become more or less sustainable, scores will fluctuate in response to those changes.
ESG reporting
| What’s needed to better analyze and implement ESG | % of North American investors who agree |
|---|---|
| Expanding/diversifying use of outside experts | 18 percent |
| Ongoing ESG training/education | 23 percent |
| Larger team of ESG employees | 24 percent |
| More automated analysis tools for ESG | 30 percent |
| More reporting from asset managers | 32 percent |
| Greater portfolio cross-industry integration of ESG factors | 34 percent |
| Consistent data from asset managers | 53 percent |
| Standardization of tools and data | 70 percent |
Source: Capital Group ESG Global Study 2022
With ESG being a relatively new area investors are looking to factor into their investment process, there is still not consistent and reliable data on ESG for investors to analyze. The standardization of data is among the most desired changes that’s needed to better implement ESG, with 70 percent of investors in North America agreeing, according to the Capital Group survey. More than half of investors also say more consistent data from asset managers is needed to better analyze ESG factors.
| Most important elements of ESG reporting | Global investors who agree |
|---|---|
| Clarity on ESG’s role in the investment process | 56 percent |
| Reporting on specific E, S and G factors | 55 percent |
| Third-party validation and review | 44 percent |
| Carbon footprints | 38 percent |
| U.N. Sustainable Development Goals | 31 percent |
| Stewardship reports | 30 percent |
| Proxy voting outcomes | 23 percent |
| Case studies | 23 percent |
Source: Capital Group ESG Global Study 2022
When it comes to fund reporting on ESG, investors are looking for more information on how a fund uses ESG factors in its investment process. More than half of global investors think clarity on ESG’s role in a fund’s investment process is one of the most important parts of reporting, according to Capital Group. Investors are also interested in more reporting on specific environmental, social and governance factors, as well as reporting around UN development goals and the outcomes of a fund’s proxy voting.
About ESG investors
While investor interest in ESG issues has increased in recent years, younger investors in particular expect their investments to reflect ESG concerns, according to a recent Stanford University study. Roughly two-thirds of millennial and Gen Z investors said they were very concerned about environmental and social issues, while about two-thirds of investors age 58 and older said they were only somewhat or not at all concerned, the study found.
Younger investors are even willing to tolerate lower returns in the pursuit of ESG goals. An average investor in their twenties or thirties was willing to lose between 6 percent and 10 percent of their investments in the interest of companies improving their environmental practices, while the average baby boomer was unwilling to lose anything, according to the study.
Young investors with more than $250,000 of wealth said they’d be willing to give up 14 percent of their wealth to advance ESG issues, the Stanford study found, while young investors with more modest savings would only be willing to give up 5-6 percent of their wealth. The study found young wealthy investors to be the primary drivers of ESG investing.
Pros and cons of ESG investing
Pros
- Investment returns can still be strong.
- Some ESG funds are available at relatively low costs.
- Money can make an impact while earning a return.
Cons
- ESG fund holdings may overlap with traditional index funds, but come with higher costs.
- Companies that score well on ESG factors may surprise socially-conscious investors.
- Data isn’t clear on whether returns are sacrificed when investing in ESG funds or if ESG investing makes its desired impact.
Bottom line
ESG investing is one of the most popular investing trends right now and is likely to remain a key consideration for investors for years to come. If you’re interested in ESG investing, you can choose whether to invest in individual companies through their stocks, or through ESG funds that hold many different companies and help investors with diversification. Be sure to research any investments before making a purchase. Some funds may hold companies that don’t align with your values, so be sure to choose investments that you think will have the impact you’re looking for.
