ESG Investing: A Luxury Good, for Now

Photo courtesy of Molly Quan

Photo courtesy of Molly Quan

By Liliya Jones

Investing in Your Values

Earlier this month Modernist became a Certified B Corporation®, joining a movement of people using business as a force for good.™ There are many ways to do this as a wealth management firm: offering our clients comprehensive financial life planning and education, investing in employees’ well-being and human capital, promoting inclusion and equity in the industry.

In addition to thorough planning, advisors can help clients align their wealth with their values by offering ESG investment portfolios. If you’ve picked up a financial newspaper lately, you know that ESG factors (Environmental, Social, and Governance) are the hottest investment trend.

Our Take

At Modernist, we think the current iteration of ESG investing is a luxury good. If like most people, you are concerned about having enough savings for retirement, you probably want to make sure you capture the highest possible returns. Thus, you may be wary of taking a risk on a new investment style with limited historical data. But if you are lucky enough to have financial planning goals that are well-funded, your underlying portfolio design is sound, and you can afford to take a bit more risk - go for it.

Here’s What You Need to Know:

Mainstream ESG products have only started coming into their own in the last decade. Currently, there are many ways to “do” ESG. You can take an active approach by only buying stocks that match your criteria. Or, you can take a passive approach and simply exclude a list of undesirable companies, industries, or countries. Or, you can adjust your relative exposure to companies based on their business practices.

What About Returns?

Many old-school financial advisors believe that ESG screening reduces returns. After all, how could it compete with investment management styles driven purely by financial merit? However, as available data grow, ESG ratings are emerging as potential indicators of performance.

For example, MSCI, the leading ESG research provider, downgraded VW’s outlook two years before the emissions-test scandal due to (you’ll never guess) “poor levels of director independence.” And a meta-analysis from Deutsche Bank shows a correlation between high ESG ratings and lower cost of capital, as well as improved corporate performance. 89% of the studies found market-based outperformance over a 3-10-year timeline.

Bottom Line

“Outperformance” sounds like a great thing! But, 3-10 years does not a satisfactory-sample-size make (there are 40+ years of data for modern global asset classes). As more data become available, the concrete effects of ESG will become clearer. We hope that those who have the privilege of well-funded retirement goals will seek to invest in their values through ESG and help the field grow.

But for now, the biggest concern for individual investors should still be the underlying structure of their portfolios – passive vs. active, diversified vs. concentrated, long-term vs. short-term, low cost vs. high cost, etc., as this is likely to be the largest determinant of performance. And it couldn’t hurt to make sure your advisor is committed to ethical business practices, i.e. a fiduciaryfee-only, or a B Corp.™