Increasing numbers of investors are starting to use their portfolios to show just how concerned they are about many of the issues facing our planet and its people. Many of them do so through a concept called ESG investing, which has become increasingly popular since the turn of the century and has continued to grow in 2021.
So what is ESG investing, and how can you use your conscience to help target future investing opportunities? Read on to learn more about the history of ESG trading, its pros and cons, how you can find ESG stocks and if investing in them might be right for you.
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What does ESG stand for?
ESG stands for environmental, social and governance. In the stock investing world, ESG stocks are those of companies that emphasise some or all three of these criteria in their everyday operations. Businesses can prioritise these factors in all sorts of ways and with a variety of actions.
Environmental criteria include considerations around how much sustainability is built into production processes and the supply chain, where a company allocates its own investment capital, its stance on climate change and efforts to fight it, dedication to renewable energy, using recyclable packaging and other green practices or donating to environmental groups.
Social factors centre on how companies treat human beings in all aspects of their business. Do employees work under safe, fair and comfortable conditions? Are workers’ rights being respected at every stage of resourcing and production (including ethical business practices overseas)? Is there a commitment to diversity and recognising other prominent social issues not only within the company, but also across society at large?
Finally, governance refers to how a company is run at various levels. This includes transparency with customers and shareholders, diverse hiring practices at the highest levels and how many different voices there are in relation to how the company is run.
Some stocks that have rated well in a range of ESG factors (more on this soon) in recent years include:
What is the history of ESG investing?
The precursor to ESG investing was socially responsible investing (SRI). SRI investing has a history dating back hundreds of years to when the Quakers refused to profit from anything related to slave trading. More recently, in the 1960s, 70s and 80s, investors started to exclude businesses from their portfolios that were involved in activities that did not align with socially conscious interests. Examples included participating in the tobacco or alcohol industries and supporting apartheid in South Africa or the Vietnam War.
While the history of ESG investing is quite subjective, today it has evolved to a general moral compass for investors to steer towards ‘ethical’ companies across the realm of ethical, social and governance factors.
ESG investing vs. SRI investing
So, how is ESG investing different from SRI investing? Both are examples of ethical investing. However, there are some key differences to bear in mind.
ESG investing and SRI investing involve using morals and ethics as a guide to choose where to invest. However, the lengths to which these factors guide your decisions differ depending on which strategy you use.
The main difference is that SRI investors use moral and ethical factors to completely eliminate companies as they build their portfolios. You remove them from your list of options regardless of how well you think they might perform in the market.
ESG investing still takes environmental, social and governance factors into account, but not always to determine the positive impact they might have on people and the planet. These factors are often used to try to predict how profitable investing in a company might be. In general, ESG investors believe those companies that score well in these three areas have a better chance of performing well financially.
What are the pros and cons of ESG investing?
As with all investment strategies, there can be positives and negatives to ESG investing.
One pro of ESG investing is that using this set of criteria can help you invest in companies that might have a lower chance of risky stock price drops due to negative attention, potentially assisting in managing your risk as an investor. Companies that consider the environment, adhere to strong beliefs in key social justice issues and are transparent, might be less likely to be involved in major scandals that can cause dramatic drops in share price. This does not mean that ESG companies are risk averse generally — simply, that they are less likely to receive negative press due to social issues.
At its heart, ESG investing aims to help investors understand the wider approach of a company beyond simply making a profit — enabling investors to make informed decisions. The UK’s FCA has outlined their approach to ESG and the importance of this type of investing. Climate change stands as a firm priority within their relationship with ESG investing, alongside a company’s ability to “drive positive change, for the benefit of its shareholders, clients and consumers, employees and wider society.”
As opposed to SRI investing, ESG investing does not eliminate businesses as investment opportunities — it just might rate them lower. This means moral and ethical constraints do not preclude you from seizing a strong investment opportunity. Another pro outside of portfolio performance is that you can invest in companies whose beliefs you share, which can bring another level of satisfaction to trading.
But there are cons to ESG investing, too. One is that there are not many standardised criteria around ESG investing. That can make it a little more difficult to determine what is truly ethical, and has seen a rise of ‘greenwashing’, where companies allude to be sustainably conscious when they are not. Positively, standardised criteria is arising on a global level, with clear definitions presented by the SRFD in the EU, as well as the ESG and TCFD in the UK so far).
Another con is that it can be hard to find sufficient information that shows just how well a company is performing in the three ESG criteria. As you will see in a moment, there are things you can do while researching to see how well companies do, but it is hard to know every detail about the inner workings of a business and its ongoing practices.
How can you determine if a stock is ethical?
You can determine if a stock is ethical in a few different ways.
One is through the wide range of rating systems out there from trusted sources. The Morningstar Sustainability Rating helps investors compare and contrast how companies in different industries rank in key environmental, social and governance metrics. Other ranking systems many investors like to look at are the aforementioned MSCI KLD 400 Social Index, S&P Global ESG Scores and Institutional Shareholder Services (ISS) ESG Ratings and Rankings and Refinitiv ESG Scores.
Another way to find out if a stock is ethical is by doing some outside research to see if any of the companies you are considering have released ESG reports. As increasing numbers of investors are placing the three key criteria at or near the top of their investment focus, companies know the importance of sharing their wins in those areas. That is why this has become more common across a range of industries. Unlike standard earnings reports, these companies decide which information to share in ESG reports — and also what to keep hidden from public view. But knowing that companies are making any efforts in all or some of those key ESG areas can help you make your investment decisions.
Also, keeping up with the latest financial markets news and analysis can help you stay up to date on companies’ many ethical actions.
What are ESG scores?
ESG scores are ratings given to companies based on how well they perform with regards to generally accepted environmental, social and governance standards. Since there are no concrete thresholds for these three areas, these ESG scores can vary from provider to provider.
While several countries such as the UK are making movements towards standardising ESG scores, there is not currently anything in place globally. However, they generally work in the same way. The scoring institution (such as Morningstar, S&P Global, ISS and Refinitiv listed above) will use a collection of performance areas that fall under the three main tenets of ESG investing. The institutions will rate businesses based on how well they do in those areas. This provides a quantitative way to compare companies. While dozens of these performance areas exist across the huge range of ESG scores out there, a few include:
Why are people turning to ESG investing?
Like all stock investment strategies, ESG investing might work for you depending on what your goals are. It can act as a compromise — it gives you a chance to exercise some ethical and moral behaviour without the stricter aspects of SRI investing. It can also lead to great returns if you think ESG properties are important to a company’s success. And with more and more ETFs and other funds out there dedicated to ESG investing, it can be easy to get started.
What are some popular ESG stocks on eToro?
If you are ready to start exploring the big, wide world of ESG investing, we’ve rounded up three of the most popular ESG stocks that you can start buying on eToro today.
- NVIDIA Corporation (NVDA) produces and sells graphic processing units for the gaming industry, as well as system-on-a-chip (SoC) units for the automotive and mobile computing industries. NVIDIA’s AAA ESG rating and strict policies around its sourcing of minerals for its products has established the company as a leader in the ESG movement. The company has shown strong returns over several years, with a current share price of $316.75*, reflecting a 135.72% year-on-year return.
- Microsoft (MSFT) is known for its software and cloud technology, and as a popular blue chip stock with a steady revenue increase year-on-year. What you might not know is that Microsoft has also been at the forefront of the ESG movement, with an AAA rating and a commitment to reaching 100% renewable energy usage by 2025. By 2050, Microsoft also plans to offset all carbon emissions it has produced since 1975. As of mid-November, Microsoft’s share price was $341.27* with a one-year return of 60.57%.
- Pool Corporation (POOL) is a wholesale distributor of swimming pool equipment, parts and supplies, as well as related outdoor living products. With a major distribution network spanning 360 worldwide locations and stocking180,000 national brands and private label products, Pool Corp. is a large player in the consumer goods industry. The company is also AAA ESG rated through its selection of Eco Select products, involvement in EPA’s WaterSense program, educational resources surrounding water management and its variety of charitable donations. In 2020, Pool Corporation’s revenue increased by 23.04% and amounted to $3.94B. The share has grown 70.52% over the past year and is currently valued at $577.85*.
* Stock price current as of November 18, 2021. ESG ratings provided by MSCI.
As mentioned earlier, other big names with strong ESG ratings include Nike (NKE) and Salesforce (CRM), as well as Accenture (ACN), Adobe (ADBE) and Alphabet (GOOG). There may be more options than you know, where companies are doing incredible work in the ethical, sustainable and governance space. These ESG stocks — or ESG ETFs — can be one way of investing in companies aligned to your values.
Sign up with eToro and invest in ESG stocks.
This information is for educational purposes only and should not be taken as investment advice, personal recommendation, or an offer of, or solicitation to, buy or sell any financial instruments. This material has been prepared without regard to any particular investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past performance of a financial instrument, index or a packaged investment product are not, and should not be taken as a reliable indicator of future results. eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this guide. Make sure you understand the risks involved in trading before committing any capital. Never risk more than you are prepared to lose.