So, you buy an ESG mutual fund or ETF and you’re excited that you’re going to change the world with your investments. But then you get your annual report and start browsing through the holdings and realize that your ESG fund is simply less bad than your traditional index fund, and reality sets in. This isn’t what you thought it was.
This happens all the time because there is no regulation when it comes to labeling funds as “ESG” or “sustainable” or anything else in the responsible investing realm. It’s the wild, wild West, buyer beware, every red flag you can think of.
Ultimately, the disconnect happens because there isn’t a universal understanding of what ESG (environmental, social, governance) or sustainable investing is. We think that it’s all the same and we want to jump in. And the people marketing ESG funds assume that you’re not going to take the time to look under the hood to see what you really own, and they take advantage of that. But it truly does a disservice to those of us who really care about making a difference in the world and aligning our investments with our values.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Too often these ESG index funds rely on traditional indexes as a base from which to invest. The problem with this is that the traditional indexes are rooted in the old economy, and you can’t invest for the new economy by looking in the rearview mirror.
The Difference Between ESG and a Sustainable Portfolio
ESG is a way of analyzing companies based on the three metrics it’s named for. It is not the be-all, end-all of the investment research process – it’s just a piece and should be considered as one component of comprehensive investment research. However, many index-based fund managers put together portfolios using only ESG metrics and very little common sense. They eliminate the step where a person asks, “Does it make sense that ExxonMobil is in a sustainable or responsible portfolio?”
By contrast, a truly sustainable portfolio is focused on a positive, solutions-based approach. What are the companies that are going to help us adapt and be more resilient to the structural and systemic risks that we are facing? It uses ESG metrics, but also looks at a new, more sustainable economy and the opportunities it presents.
I like to look at it this way: An ESG portfolio that reduces its allocation in ExxonMobil is less bad. A portfolio that eliminates it entirely is better, but a portfolio that buys First Solar (FSLR) in its place is both sustainable and responsible.
To Be Sustainable, You Have to Go the Extra Mile
A sustainable portfolio requires forethought and analysis beyond basic fundamentals and ESG metrics. It includes understanding the new economy and which technologies, sectors and industries are going to be market leaders and changemakers. In some cases, it might be traditional industries that are rapidly adapting, or it might be a technology that didn’t exist five years ago. It could be sustainable real estate and green building technologies or the rapidly expanding world of batteries, electric vehicles and other forms of green transportation. And beyond the obvious like clean energy, opportunities exist in cutting-edge biotechnology to cure disease and help people live longer, healthier lives. A healthier society is a more sustainable society.
If your ESG fund isn’t actively looking at its holdings from a similar solutions mindset, then it isn’t sustainable.
What You Should Do as an Investor
The best way to avoid the greenwashing that is happening in the ESG investing world is to do some basic due diligence. Before you buy a fund, take a look at its holdings – if something doesn’t seem right, it probably isn’t.
Don’t just trust the label because the reality is that virtually all of the widely distributed ESG indexes aren’t sustainable. Find an investment manager who actively invests in solutions to the world’s greatest problems and avoid the ones who are simply trying to be a less bad version of traditional indexes.
-
The US Postal Service Does More Than Deliver Mail: Six Ways It Helps Older AdultsWith talk of cuts to the USPS swirling, here are the ways it provides vital services to the nation’s older adults.
-
Stock Market Today: Stocks Seesaw After Big Market RallyThe latest consumer confidence data showed sentiment remains low.
-
Would You Benefit From Investing in Cryptocurrency?Understanding the complexity of adding digital currency to your investments is critical, especially since drastic price changes can happen very quickly.
-
Why Company Stock May Be Riskier Than Employees RealizeStock compensation has its perks, but employees must be realistic (and unemotional) about their investments' prospects. Sometimes strategic sales are smart.
-
Can You Be Fired for Going to Work When You're Contagious?What's an employer to do when an employee shows up at the office with a cold or the flu and spreads germs to co-workers?
-
Social Security Fairness Act: Five Financial Planning Issues to RevisitMore money as a public-sector retiree is great, but there could be unintended consequences with taxes, Medicare and more if you're not careful.
-
Social Security Warning: Five Missteps Too Many Women MakeClaiming Social Security is complicated, and for women the stakes are high. What you don't know can cost you, so make sure you do know these five things.
-
To Buck the Third-Generation Curse, Focus on the Family StoryThe key is to motivate the next generations to contribute to the family business in a productive way. You can look to Lawrence Welk's family as a prime example.
-
How Roth Accounts Can Ease Your Tax Burden in RetirementStrategic Roth IRA conversions can set you up for tax-free income in retirement and a tax-free inheritance for the people you love.
-
Are You a High Earner But Still Broke? Five Fixes for ThatIf you're a HENRY (a higher earner, not rich yet) but feel like you still live paycheck to paycheck, there are steps you can take to get control of your financial future.
