53. Investing for Good: Understanding ESG Investing
Investing for Good: Understanding ESG Investing
More people are making a point of being intentional with how their money is invested. Focusing on environmental, social and governance (ESG) factors is one way that you can align your values with your investment strategy. In this episode we discuss all things ESG including some concerns and whether we think ESG is just another gimmick.
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TOPICS IN THIS EPISODE
1. What is ESG?
2. Benefits of an ESG investing strategy
3. Issues with ESG and whether it's just another gimmick
4. Where do you find ESG investments?
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Dividend Investing
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Transcript:
Evan Neufeld: Hello, and welcome back to the Canadian Money Roadmap podcast. I'm your host, Evan Neufeld. Today we're talking about a bit more of a trendy topic in investing, the idea of ESG or doing good with your investments. Welcome back Jordan. This is a fun topic today, ESG investing.
Jordan Arndt: Yeah. I'd like to do good with my money. Tell me more.
Evan Neufeld: Well, a lot of people are thinking about that these days. I said it was trendy in the intro, but people are becoming more and more aware of what they're investing in and they want to make sure that they are investing in things that they can align with from a moral standpoint, sometimes political standpoint, a variety of different things. So ESG is one of the catchall terms for that. You might have seen it in headlines or in ads for investment products, but what is ESG Jordan?
Jordan Arndt: What is it you might have heard sustainable investing or socially responsible investing. Yeah. SRI is another one. Yeah, it's kind of all the same, but you know, hopefully all jokes aside, being aware of where your dollars are going is probably a good thing. So I think there's some good things we can break down here to frame that. Essentially ESG, if we look at that category, the letters stand for environmental, social and governance. So environmental, think of conservation of the natural world. Social is consideration of people and relationships and then governance being standards for running a company. We can give some examples of each category, but that's essentially what ESG is trying to encompass, right?
Evan Neufeld: When you think of environment, you can think climate change, carbon emissions, pollution, energy efficiency, waste management, water management. There's a lot of things in there, some are more important to people than others of course, I'm going to come back to that. And then in the social factor consideration of people in relationships, think privacy or diversity and inclusion. So that would be, say a company including people of color or different genders on their boards of directors, so the people that are making decisions on behalf of a company. Employee engagement, community relations, human rights, labor standards. I've had a lot of clients say like, I don't really care, but if I could make sure that my money's not invested in slave labor, what a low bar. Yeah, but that, that is the social factor in ESG.
Governance is a little bit more esoteric and not as top of mind for many people, but still really important when we kind of structure these things together. Board composition, I guess I talked about that in the social side of things, but bribery, corruption, lobbying political contributions. The idea of having whistleblowers within your company, you don't want to have any issues that actually require a whistleblower of course. Executive compensation is another one too. So those are a lot of factors that are considered when investing in ESG. So at a high level, ESG investing is looking for companies that are focused on more than just the bottom line. Performance of course is important. That is the mandate of a publicly traded company is to provide value to shareholders, but seeking to invest in companies that are looking to score highly in some or all of these ESG categories is the whole point. How do they do that? How do you even come up with all these things, it sounds like it's pretty tough to know.
Jordan Arndt: Yeah and issues may be the wrong word, but just one of the challenges, I guess, with this kind of subset of possible investments that you could be looking at is how is it really defined? How is your ESG score calculated? If you go on Morningstar, they have a sustainability number that they assign to companies. If you look at various asset managers or fund companies they'll have ESG scores and they'll maybe brand it something else or call it something else. How those numbers are calculated, I guess you'd have to look at each one separately and there's probably some overarching themes to all of them. But it is a little bit nuanced and so the metrics behind it or how you maybe would score in these areas is it's not standardized. How someone looks at it might be completely different. Companies will report themselves too, so when they're doing their annual reporting on whatever frequency they might be including ESG terms and metrics that they've perhaps created and to show that they are improving in these categories. So anyways, that one's hard to define. There's a lot of different ways you can take that and someone might say one company's scoring highly or good in an ESG category, or someone else might say the opposite depending on how you look at it. So there's not one true definition to that.
Evan Neufeld: Yeah, unfortunately and that's at the cost or the detriment of the investor. I think we'll get into some of the other issues later, but yeah to understand what companies or what funds or what ETFs are ESG focused you have to look at their marketing material a little bit and read through some of the noise there. Like you said, sometimes in these conference calls that companies have, they know where their bread is buttered, right? If that's something that's interesting to investors, even companies that have no affiliation with any of these types of industries or business practices, they're just going to drop buzzwords in there. So ESG is something that I think is really important, but you have to put a little bit of, you know, a critical lens the way that you view some of these things, to make sure that you're not participating in something that's being greenwashed for lack of a better term there. But anyways, let's backtrack and say okay, why might you want to consider ESG investing? Let's look at the other side of the coin.
Jordan Arndt: Yeah. I think often for a lot of people, it's personal concern for the cause or just something that they feel like they can relate to. So often people think of the environmental component of this. And so perhaps climate change, carbon emissions, pollution, whatever, maybe that's something that's just really important to you. So you want to make sure that your dollars that are being invested in public markets and public companies are going towards companies that are either good in this space or improving and seeking to make the world better and you can take that to the social and governance aspect as well. So it's probably something that hits home for you personally, that might trigger why you want to invest in these sort of companies.
Evan Neufeld: Yeah. Along with that, there is a growing subset of people that believe that there could also be investment outperformance for these types of factors. Because non ESG factors, so the companies that are using slave labor and are larger emitters all these different things, those are starting to be seen as real business risks as opposed to nice to haves, you know, as part of your business. And so if the most ESG compliant businesses are being rewarded by shareholders and more interest in their stocks, then the share price should outperform and so on and so forth, right. So this is tough to put out there. This is relatively new. I like to see evidence over a longer period of time, but you know, to me that that's not completely crazy.
Jordan Arndt: There's a thesis there that I think makes sense.
Evan Neufeld: Yeah. So that's why you might want to get into ESG investing. So, how much money is in this stuff? Like, are people actually doing this?
Jordan Arndt: Yes, and growing quickly.
Evan Neufeld: I'm playing devil's advocate here with my shock.
Jordan Arndt: Bloomberg, I think you said, what was it? 2.7 trillion?
Evan Neufeld: Yeah and that's invested globally in mutual funds and ETFs specifically with ESG focus. That's a lot of money. There's lots of fund companies that their specific funds won't have an ESG focus, but at the top level they will. So the waters are a little bit muddy. They're 2.7 trillion dollars, that is huge and that has grown significantly just in the last two or three years here. That was at the end of 2021. So if, you know you're getting almost $600 billion in that we might be looking at well over 3 trillion by this point. Yeah. So that's a lot of money. And so back to my critical lens idea, if there's a lot of money flowing into these things, you can expect that a lot of investment firms will want to start dipping their toe in there. Again, just make sure you understand what you're investing in and that it is something that you are actually aligning with. Just because it says ESG doesn't mean it's going to be great for you necessarily. Another thing to keep in mind too is that ESG style investing is relatively new here in Canada. I don't have too many US listeners being the Canadian Money Roadmap, but here in North America, it's relatively new. Whereas in Europe it's been around for much, much longer, and it is much more prevalent for a variety of reasons. I'm not going to get into that, but of that 2.7 trillion, I've seen numbers as high as 80% of that being located in Europe. So I think it's going to grow a lot more here in north America, just as time goes on. Okay. Let's go back to some of those issues about ESG investing. What are some of the main ones that people should be aware of?
Jordan Arndt: Yeah, I think One of the issues that that certainly comes to mind is, we kind of touched on it already, but a lot of people are really just interested in the E part of the ESG, or at least that seems to be the part that people are drawn to most easily and maybe it's the most transparent and just the social issues that are kind of the day. The investment might be labeled as ESG, but it might not match what you want. So maybe it scores high on the E category, but it's actually quite poor in G but improving on S or something like that. It's tough to know exactly. Is that good? Is that what you want? Is that an ESG company? Well, maybe, I think it's a hard place to say yes or no, but because you're maybe interested in one of the categories more than the other, you might be surprised what then gets lumped into an ESG fund, for example, that has a collection of many stocks or options that it's invested in. I think that's one of the issues that seems to come up.
Evan Neufeld: Yeah. For example, here, I'm not picking any one fund in particular, but apple is the largest company in the world. And apple ends up in a lot of ESG funds. Any idea why? They make computers and iPhones and software and whatnot. It's like, well, that's not a ESG company, but most of their products are now fully recyclable and they have really good board diversification and all these other things, right. That's like when you look at some ESG definitions, they tick a lot of the boxes, but they're not out there making solar panels, you know? And so you might be surprised to see apple, oil and gas companies and why would an oil and gas company be in an ESG fund?
Jordan Arndt: Yeah, I mean, they might just be improving, right? Their carbon emissions might be X today, but it was 2X a year ago and it's projected to be half of that a year from now. And so the trend that it's headed in might consider it to be an ESG company. Again, not commenting whether it should or shouldn't, you know our opinion on that. But, you know, if you want to get into ESG, for example, for the solar power, renewable route, just be aware that, you know, there might be companies that fall in there that maybe don't meet your mandate or the reason why you wanted to invest in the fund to begin with.
Evan Neufeld: Or you could see it from the other way of like, I'm pulling this out of the air, I don't know if it's legit or not. But like see BP, like British Petroleum. I know that they spend a lot of their capital expenditure on renewals. So they're one of the largest producers of oil today. But if you see it in there, that almost should be reassuring in a way to say that, okay this company’s got to be doing something more than just trying to stick more holes in the ground here. I think that's a great point. Yeah so whatever, maybe call that an issue, opportunity, whatever. It's just being aware of what that is. And maybe start asking questions of what companies might be included in some of these funds. Another thing to consider, I mentioned performance is a reason you might want to invest in it. And performance is a reason why you might not want to invest in it. Because there's a lot of, call it emerging technologies. These might be new companies, even things like beyond meat might be in there because meat is often seen or like say cattle production is a large emitter of greenhouse gases. So the alternative is seen as is better for the environment. These are new companies and they're not well established and so they're largely going to be driven by speculation in prices or as opposed to earnings, because it's tough to get these companies off the ground. Lot more volatile, potentially. Tons of science project type companies, they don't have reliable cash flows and whatnot. So when you bundle all these together, it could be great if everything works, but it could be really bad too. So if you invest in an ESG specific fund, just know that your performance is not necessarily going to look exactly like, the TSX or the S&P or the Dow Jones or something like that. It's going to look different. Again, maybe not better or worse, but your performance might be a little bit more volatile than usual.
So because there's these issues and opportunities and potential marketing and it's growing like crazy and whatnot, is ESG just a gimmick?
Jordan Arndt: I feel like I can't take a stance on this one. I feel like I'm going to tow the line in between and say potentially yes and no.
Evan Neufeld: There's opportunity for it to be.
Jordan Arndt: Absolutely. You know, I think you could question whether ESG scores or stuff like that, are they actually leading to meaningful change over the long term or are company's just aware of it.
Evan Neufeld: Theres a lot of evidence that says no.
Jordan Arndt: Exactly. And so potentially you could call that gimmicky. You know, the fact that there's no standardized definition. I think that makes it hard to under understand what ESG is actually and define it. However, I think also on the flip side, no, it's not gimmicky, I like to think that if it's better for the environment, if it's better for society, if companies are being more well run and checking some of those things that we talked about earlier, like just philosophically, that just that seems better to me and that seems like a good thing. So that's not a gimmick in my opinion. I kind of think in the future ESG, it's not going to be a category. Like it's just going to be kind of table stakes to participate. And as information becomes more and more available and you know, we're just more aware of what companies are doing. Is ESG going to be a thing or is every company going to be environmental, social and governance focused? Who knows you hope so, right? But that's not today, that's not tomorrow and who knows if we ever get there. So I don’t know, Your thoughts?
Evan Neufeld: I would agree with you. I don't think it's a gimmick, but at the same time, another thing that I'll touch on that you didn't there is that when you invest in individual stocks or mutual funds or ETFs that are focused this way, what you are doing, this is just very logistically, you're participating in the secondary market. When a company first goes public, they do something called an IPO or initial public offering, and they raise money and that allows them to grow and implement their technology and build their product, things like that. But once those shares exist, I'm oversimplifying here, but once the shares exist now, Jordan, you and I are treating those stocks between you and I and millions of other people. That company doesn't see a lick of your effort. Right? So if you buy a hundred shares in a solar power company. They don't see any of that money. Okay. You're not giving them money. You are giving the previous owner of those shares that money, right. So there is a little bit of a disjointed thing between, yes, I'm doing really good, I'm investing in ESG and whatnot. It's like, well companies didn't see any of that. However, how does that actually play out. Well, when you are a shareholder, you actually have a say in a lot of things that happen at that company. When you own one to a hundred, even a thousand shares in a company, you don't get as much, but you do get to vote on these things. And so when it comes to ESG investing, there's a little something called activist investing that happens there. This is when significant shareholders can really start to push companies into a different direction. We call it reforming, or I've heard it called reforming these companies. And so maybe encouraging an oil and gas company to start investing more in renewables and if you have enough shareholders that are saying that, okay, then that actually makes a difference. But from an actual dollars and cents perspective, you can think you're doing more than you actually are like at, at our scale here a little bit. But it's not a bad thing either, you know? So again, firmly in the middle on this one, but some things to keep in mind. Okay. If this is something that you are interested in, what types of ESG investments are out there?
Jordan Arndt: You could find individual companies, stocks to invest in but you can also find pooled structures like a mutual fund or an ETF that'll have different focuses.
There's different types of mandates within those two types, you know, mutual funds or ETFs and we can get into that, but really can find ESG investments just like you'd find a different investment per se.
Evan Neufeld: Yeah, I would typically see two main categories of ESG, one being exclusionary and another one I'll call thematic. Let's start with exclusionary. So when clients have asked me about that, they usually have something in their head, it says I don't want to invest in tobacco companies. I don't want to invest in weapons manufacturers. I don't want to invest in oil and gas, whatever the case may be. And so in that case, an exclusionary fund might be good. So sometimes an ESG focus fund will say at the very top, we don't invest in tobacco, alcohol, adult entertainment, weapons, in some cases, nuclear, whatever, all these different things that people might not like. And then from there, then they do their screenings and they find the companies that are appropriate from there. So that would be an exclusionary mandate. Just be aware that not all exclusionary mandates exclude the thing you want them to exclude. Anyways, just some to be aware of there. Now, on the other side, the other category of ESG fund or ETF would be something like a thematic. So if you are specifically looking for renewables, renewable energy, water security food security, all these different things. There's going to be something that scratches your itch. Again, that doesn't mean that it's good or bad, but there's thousands of funds out there that there's going to be more every day. Yeah. So by definition though, if you're looking for an exclusionary mandate, a thematic fund might also do that same thing. So if you are generally looking to do good with your money, a thematic fund will probably just exclude tobacco by nature because that's not the types of companies that it's looking to buy within its fund. But anyways, those are some of the things that you can look for when looking for ESG investments.
Okay. So maybe to wrap things up here, ESG again, that's environmental, social and governance factors. This is a style of investing that you can incorporate within a diversified portfolio these days. It's becoming less niche over time. Things to keep in mind. even though you have something in mind for what is important to you, that product or fund, ETF, whatever that you're buying might not scratch the itch as much as you want and there's a lot of other factors at play including just marketing because a lot of money is going there. Make sure you understand what you're investing in, whether that's important to you and understand that the performance is not always going to be similar to a completely well diversified portfolio. Things might be a little bit more volatile, fees - I didn't talk about this because it's a bit more niche. Sometimes the fees are a little bit higher for products like this, but generally speaking for people that want to do more good with their money, that's kind of a secondary factor for them. But yeah, just keep in mind everything that's out there. Try to look through some of the gimmickry that exists. But if this is something that you're interested in, you can talk to your advisor and see if there's decent options out there for you. Thanks so much for listening today. If this was interesting for you, please follow along on the podcast player of your choice and Spotify, apple music you can click follow along and you'll hear new podcasts from us every couple of weeks. Thanks so much for listening and we will see you soon.
Thanks for listening to this episode of the Canadian Money Roadmap podcast. Any rates of return or investments discussed are historical or hypothetical and are intended to be used for educational purposes only. You should always consult with your financial, legal and tax advisors before making changes to your financial plan. Evan Neufeld is a Certified Financial Planner and Registered Investment Fund advisor. Mutual funds and ETFs are provided by Sterling Mutuals Inc.