Values-based investing has evolved over the years. It started with socially responsible investing where investors avoided investments that didn’t match their core beliefs.
Avoiding firms that sold alcohol, tobacco, firearms, gambling, contraceptives, medical procedures and military equipment were common screens for socially responsible investing. These screens weren’t likely to change corporate behavior, but investors avoided putting their money to work in companies offering a product or service they didn’t approve of.
From those beginnings, some investors are now looking to have more of an impact on corporate behavior with investments that consider the company’s environmental, social and corporate governance principles. This is known as ESG investing.
The ESG score
A company earns an ESG score based on its rankings in these 3 areas. Several firms provide these rankings, including Morningstar, Bloomberg and Sustainalytics. Morningstar plans to offer ESG rankings for mutual funds and ETFs, starting in 2016.
ESG still evolving
Anthony Valeri, Investment Strategist at LPL Financial Research, wrote a white paper recently on ESG investing titled “Aligning Investments and Values.” Valeri pointed out that ESG investing is new enough that there is not general agreement on how to define what ESG investing means.
ESG investing can be done with an individual stock, with mutual funds or with exchange-traded funds focused on ESG parameters.
Millennials embrace impact investing
Valeri pointed out that millennials identify more with impact investing, and that they’re soon to be the biggest investment client base in the market. They seem to have a greater awareness of it and greater desire for it.
Let’s take a look at how companies get an ESG rating. The environmental scores are based on how sensitive a company is to environmental concerns in running its business. Alternative energy companies would be expected to have high environmental scores. A coal mining operation would be expected to have a lower score.
Social scores are based on how the business interacts with its workers and its community. Workplace safety records, health care and retirement plans would all influence a company’s social score.
I asked Valeri whether Wal-Mart’s social score went up when it announced a plan to increase its employees’ pay. He said that while its ESG score would theoretically go up, there’s a bottom-line expense that impacts the company’s earnings per share.
Corporate governance scores
Finally, the company is scored on its corporate governance. A company that separates the role of chairman and CEO would score higher, as would one that uses outside directors, especially for audit and executive compensation matters.
Gender and ethnic diversity on the board and in senior management also can play a role in the governance scoring.
Will ESG investing take off?
According to Valeri, “The jury is out. So far, the people haven’t spoken with their dollars yet. It’s still early.”
Do you make investment decisions using socially responsible investing or environmental, social and corporate governance principles?
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