Why ESG Investing Just Makes Sense

For some investors, the concept of ESG investing may represent something of a change to how things used to be done. After all, isn’t investing about making money? Isn’t that what firms and stocks are for? As someone with many years of experience in the financial world, I understand this argument—but I don’t believe it’s right. In fact, if you really think about it, ESG investing is a wider and more effective look at the factors we are already assessing. Let’s take a closer look.

Systemic Risk

To use an appropriate metaphor, historically we have looked at companies (i.e., trees) without looking at the wider economy (i.e., the forest). And that made sense, because historically the trees could thrive independently of the forest. The health of the forest was assumed to be fine, regardless. And if that is the case, why worry about it? What we have learned over the past 20 years, though, is that if the forest is threatened, so are the trees. Here, I want to abandon this metaphor for a moment and go back to finance.

Remember the great financial crisis (GFC)? When the system itself looked threatened? When even strong companies, or what were thought to be strong companies, teetered and collapsed? In that case, it was proven that the larger system (the forest) mattered. That trees couldn’t thrive in the middle of a forest fire. That looking beyond the companies, at the systems and the systemic risks, was necessary as investors. So far, so good, and this view is now accepted.

But why should we limit this broader perspective to the financial system itself? Why shouldn’t we extend it to areas like the environment, the social impact of firms, or their governance? What makes them not relevant in the same way we learned the broader financial system was relevant?

A New Window

Looking at it that way, ESG becomes a natural extension of the broader perspective we got from the GFC. It looks like a way to take into account risks that will affect our investments, before we get a systemic crisis. It looks like what we should have been doing with the financial system itself, before the GFC.

And that holds independently of politics. Shouldn’t we be looking at all risks and opportunities? Shouldn’t we be considering the longer term? Both of those are investing 101. ESG gives a new window into that process, and it’s one that can make financial sense.

This perspective is getting more widespread. Almost all investment companies now offer at least a nod to ESG processes, if not specific products. ESG, like any useful discipline that can help investors understand and improve their analysis, is rapidly becoming a standard. You don’t have to agree with some of the politics of the ESG advocates to see the real utility of the mindset or to take advantage of it.

A Better Understanding

As an investor, it’s not about the politics. Note that I have not mentioned politics, or climate change, or sustainability, or any other politically charged terms. All we are looking at here are systemic risks and opportunities offered by the environmental, social, legal, and financial contexts within which any company operates. All we are doing is extending the context in which we evaluate those companies. All we are doing is better understanding our investments. That is something I want to use in my portfolio.

Investments are subject to risk, including the loss of principal. Environmental, social, and governance (ESG) criteria are a set of non-financial principles and standards used to evaluate potential investments. The incorporation of ESG principles provides a qualitative assessment that can factor heavily into the security selection process. The investment’s socially responsible focus may limit the investment options available to the investor. Past performance is no guarantee of future results.

Brad McMillan, Contributor