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By Brian Walsh Jr., CFP®
We have seen a growing demand for environmental, social and governance (ESG) and socially responsible investment (SRI) solutions across the world in recent years. In fact, investments in U.S. ESG funds surpassed a record $ 51 billion in 2020, more than double the previous year’s total and nearly 10 times higher than 2018 levels, according to Morningstar.
The coronavirus pandemic and the social / political events of 2020 have clearly highlighted the crucial role businesses can play in driving positive change, and investors want to be a part of this movement.
Let’s take a look at some of the top reasons ESG investing is gaining traction today and why it deserves a place in your retirement portfolio.
Factors driving demand for ESG investments
1. Access to information and interest of emerging investors
Today’s investors have more access to information than ever thanks to the Internet and technological advances. From tracking regulatory filings online to tracking companies on social media, investors are able to conduct extensive research and due diligence before deciding to invest. Gone are the days of companies operating in silos, with their management teams sitting atop ivory towers and facing little or no repercussions on their business decisions. With company policies and practices now widely publicized, investors are able to act as watchdogs and hold companies to account.
As these business dynamics continue to change, so will investor behavior. There was a time when people invested almost exclusively in large conglomerates, banks and corporations that often had their own interests at heart. This money is now entering the largest generational transfer of wealth in history. Over the next several decades, an estimated $ 59 trillion is expected to fall into the hands of millennials and young investors who want their portfolios to better match their personal values ​​and contribute to positive change. For the record, more than half of our firm’s millennial clients have specifically raised or asked about ESG investment options in recent conversations, demonstrating that there should be a clear demand for these products. in the future.
As such, we are likely to see a major shift in how investor dollars are allocated in the future, with ESG potentially poised to benefit.
2. Corporate governance improvements
Corporate governance is a crucial facet of ESG, encompassing the structure of rules, practices and processes used to run a business. In recent years, we have seen many improvements in corporate governance, particularly related to greater representation of women and people of color in leadership positions.
In fact, research has indicated that at least 30% representation of women in leadership positions adds an average of 6% to a company’s net profit margin. In addition, companies that score well below average on good governance policies are significantly more prone to mismanagement. This is because companies that build diversity into their workforce and into their boards invite greater diversity into their systems, processes and strategic decision-making, thereby reducing the likelihood of major gaps in business. company policies. Not to mention that when companies have strong corporate governance protocols in place, their social and environmental policies are more likely to align.
Change starts at the top, and companies engaged in corporate governance are also likely to be the primary drivers of overall social, environmental and economic impact. Adopting ESG-focused policies creates positive outcomes not only for a company’s shareholders, but also for its employees and customers. Simply put, taking this approach improves the business, and those who fail to implement the appropriate ESG standards in the future will likely be left behind.
3. Performance
Historically, ESG has been a relatively expensive topic to incorporate into a portfolio. The fees for ESG-focused mutual funds were much higher, which detracted from performance. Now, investors no longer need to rely on expensive funds to gain ESG exposure. Instead, they can easily invest in a low-cost exchange-traded fund (ETF) such as the iShares ESG Aware MSCI USA (ESGU) ETF.
For context, since the market bottom last year from March 2 to December 31, the ESGU has risen by 20% while the benchmark SPDR S&P 500 ETF Trust (SPY) has only risen by 17. %. In addition, ESGU has outperformed SPY by 6% over the past three years and by 8% over the past five years.
Overall, businesses that were able to pivot quickly once COVID-19 hit were in a much better position for growth over the past year. Not surprisingly, many of these companies also had ESG-friendly policies in place. A good example is Tesla, which gained 743% last year despite the sell-off and market volatility that followed. ESGU was exposed to Tesla, unlike SPY. So not only does ESG provide an opportunity to invest in companies that do good for the world, but it also offers the potential to generate significant returns over time.
4. Regulatory environment
The International Energy Agency reported last year that investor dollars are shifting away from fossil fuels at an accelerating rate, amid growing uncertainty surrounding fuel demand in light of the pandemic. In fact, renewables held up better than any other energy source last year.
Such developments are occurring in the context of the infrastructure bill proposed by President Joe Biden. Called the American Jobs Plan, this bill aims to improve transportation, high-speed internet and clean energy, among other initiatives. This move towards a “green economy†will put sectors and companies that follow ESG mandates in a more favorable position.
For example, semiconductors will be at the heart of many proposed infrastructure projects. As a result, chipmakers like Nvidia and TSM are expected to perform well, along with others contributing to the advancement of clean energy and technology (e.g. Natera, Pacifica Biosciences). All of these companies reflect the ESG theme and investors should gain exposure to them as part of a diversified portfolio going forward.
In the wake of Covid-19, we are also seeing companies like Zoom, Square and PayPal disrupting the way we work and live, highlighting the growing shift towards digital capabilities and the move away from brick and mortar. Services such as telehealth and virtual tours have propelled our healthcare system forward, which will continue to progress and potentially reduce the overall carbon footprint.
Take advantage of ESG trends
With this industry so ripe for opportunities, how should retirees go about implementing ESG in their portfolios? The simplest answer is to trade a standard S&P 500 index fund found in most traditional portfolios with a large cap ESG fund, such as ESGU. This way, you still have broad exposure to high performing and liquid companies, while excluding those that do not meet ESG mandates.
As with any investment, there may be short-term risks that impact the immediate returns or performance of ESG funds. For example, if some of the regulations described above are delayed when the market price is set for them to be enforced, ESG investments could experience a period of short-term volatility.
Over the long term, however, it is important that investors of all generations position their portfolios to take advantage of trends that drive the market forward. As more companies change their mindset and leadership structure to align with ESG standards, companies that fail to fulfill these mandates risk being left behind. This is why I firmly believe that ESG should be at the heart of any investment strategy, even if you are retired or about to retire. If you want to explore ESG investing, work with your financial advisor to determine if it matches your financial goals.
About the Author: Brian Walsh Jr., CFP®
Brian Walsh Jr., CFP®, is a Senior Financial Advisor at Walsh & Nicholson Financial Group, headquartered in Wayne, PA. Prior to joining Walsh & Nicholson, Brian served as Senior Vice President of Investments at Lincoln Financial Group. He also holds the Certified Financial Fiduciary (CFF) designation and is a Certified Fund Specialist (CFS). Brian also holds Series 7, 6, 63, 65 Life and Health Insurance licenses.
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