Increasingly, investors are searching out investments that align with their values. Assets invested with money managers that incorporate ESG criteria—screening for environmental, social and governance issues—grew from $1.4 trillion in 2012 to more than $8 trillion in 2016. But while demand is rising for ESG investments, there is a lack of clarity around the criteria investors and portfolio managers use to evaluate these types of investments. How should ESG be defined? Should it be an overall evaluation of the company, or an evaluation of the product produced by the company?
This uncertainty makes it all the more important for investors to understand how to evaluate ESG investments and to better understand how the funds in which they invest select their holdings. After all, investors often look to ESG as a way to align their values with their investments. Gaining a clearer understanding of the ESG investment process can offer an instructive roadmap to investors hoping to become more knowledgeable about their own ESG investments.
Understanding the ESG universe
Among ESG funds, investors will find portfolios that have a broad mandate to invest in socially responsible companies. Socially responsible investing (SRI) often looks broadly at a company’s impact on a range of environmental, social and governance issues. SRI funds make up the bulk of the ESG market.
Impact investing is a smaller piece of the ESG landscape. Impact funds often evaluate companies on a single issue. Some funds may only invest in companies in which women make up a meaningful number of the senior management team and the board of directors, or in companies directly involved in renewable energy sources such as wind or solar. For example, the AllianzGI Global Water Fund has three primary objectives: it invests in companies that improve water supply, water efficiency or water quality.
The variety of funds in the ESG universe gives investors more options to find investments that truly align with their values. It also means that not all ESG funds are alike.
It may surprise some investors that Elon Musk’s Tesla isn’t a perennial favorite among ESG money managers. After all, the company makes environmentally friendly products such as electric cars and energy storage systems. But while Tesla’s end products are very environmentally friendly, the firm by some measures receives low scores on governance and social issues due to factors such as employee compensation, employee turnover and even cybersecurity measures. The company’s governance model, for example, is a source of concern because Mr. Musk holds so much power at Tesla. That’s not a judgment of his abilities, but a judgment of how the governance and voting rights are structured. That said, Tesla may find a home in portfolios that put more emphasis on a company’s end products than on internal measures such as employee turnover or management control.