I know that some of you are on board with ESG investing. And I also know that some of you might think that it is bunk. For me, it is truly not about politics, but rather what works well in the stock and bond markets now.
I have read, listened to and had the tremendous privilege of meeting Dr. Milton Friedman. He was the Nobel Prize winning economist that was predominately at the University of Chicago. He was an ardent supporter of the free market. And while ESG was not yet a common investment phrase — he was critical of companies that took efforts toward causes other than shareholder returns. He thought that doing so made companies less productive and profitable.
But even Uncle Milton would now agree that today, the market-driven forces are justifying investment in ESG right now.
ESG investing stands for environmental, social and governance. And it is both a category of companies as well as a scoring mechanism of companies. The basic nature of ESG is that it is a means of investing that will not only provide growth and income, but one that has a better impact on the environment, society and shareholders.
Beyond the Basics of ESG Investing
But what does ESG really mean? How should you conceptualize each of the components?
Environmentally friendly means greater use or production of clean energy along with less impact in terms of waste and material use. This is not a drag on most companies –including energy and utility companies — that continue to drive growth and more income from renewable and cleaner energy production.
Social concerns bring in the practice of involving more stakeholders into the decisions of companies. It means that companies are more aware of the impact on communities as well as consumers. It can be a grab bag for lots of other causes — but at its core — social responsibility should drive consumers to have a more favorable view of a company.
Governance includes better recognition of shareholders’ rights. This means independent boards of directors, more transparency in executive compensation and greater disclosure of company activities and financial conditions. All of this I have always been in favor of — including having separate CEO and chairman positions. I am also a fan of greater disclosure throughout the year and in quarterly reports.
Investors Are Now Demanding ESG
Individual investors are still a smaller part of the stock and bond market in their direct investments. Institutional investors continue to dominate in activities and holdings. And while many institutions are run privately for the benefit of their founders, more are run for the benefit of different cohorts.
Think pension funds or endowments, which make up a large portion of the capital market in the U.S. and beyond. The beneficiaries of these funds are demanding that fund management invest more in ESG-compliant or ESG-focused companies. And historically, beneficiaries have had a large sway on fund management when it comes to several targeted issues or agendas.
This is bringing the concept of ESG investing further into the boardrooms and C-Suites of companies. Additionally, fund managers are directing more capital to ESG-friendly companies.
BlackRock (NYSE:BLK), a stock in a dividend-focused portfolio within Profitable Investing called the Incredible Dividend Machine, has been making larger investments in ESG. Larry Fink, the founder and CEO of the company, is a big proponent of ESG. He has led the asset management company to roll out a series of funds including a major initiative in its dominating exchange-traded fund collection.
And the ESG market has been showing good performance. The S&P ESG Index has returned 214.4% over the trailing 10 years.
S&P ESG Index Total Return
And over the past trailing year the ESG index has outperformed the S&P 500 by 18.8% in better total return. This shows that ESG can be more defensive or reliable and may well attract more capital than the general stock market going forward.
S&P ESG and S&P 500 Indices Total Return
How to Pick the Right Stocks and ETFs for ESG Investing
Now, ESG compliance is a squiggly bit of analysis. On my Bloomberg Terminal there is a function that takes a lot of compiled data and comes up with all sorts of embedded ESG criteria. This means that even a petrol royalty company such as a favored Viper Energy (NASDAQ:VNOM), the landlord of the Permian Basin inside my Profitable Investing, is not negatively rated overall in its ESG analysis.
So, ESG compliance can be achieved across industries at some level. But I want to direct your attention to three companies firmly leading in the ESG green energy space and then direct your attention to three ETFs in the general ESG markets that…