With growing choice in approaches, starting on the right foot is more crucial than ever
While ESG investing encompasses many approaches and includes many objectives, its proponents agree on one thing: the results can only bear out in the long run. That means rather than opportunistically pursuing the deal of the day, investors must have a sense of their true north — and that requires answering one important question.
“I believe that choosing an ESG strategy comes down to knowing what kind of ESG investor you really are,” Peter Lazaroff, chief investment officer at Plancorp, told the Wall Street Journal.
Emphasizing that investors must know and be willing to accept the challenges of a particular approach, Lazaroff said that investors must reflect on what their motive is.
Some may have a strict stance, which would require keeping their investments aligned with their beliefs and values, even at the cost of performance. He suggested that exclusionary screening or thematic and impact investments may be desirable for such hardliners, but cautioned that such strategies come with limited diversification, which could mean lower long-term returns.
The other school of thought, Lazaroff said, has more consideration for financial returns; investors in this camp might want to do good while doing well, or might want to pursue ESG with the understanding that it promises better returns in the long term. He suggested that this group would be more inclined to use a positive screening or ESG integration approach.
“Rather than excluding companies for their products or activities, a positive-screening approach seeks to give greater weight in a portfolio to companies leading their industry in ESG best practices,” he said, explaining that portfolio managers using this approach look at companies from a given investment universe, score them based on a host of ESG factors, and allocate the most dollars to those with the highest marks.
An integration approach, meanwhile, uses ESG criteria such as climate change, social inequality, and corporate governance alongside other traditional financial analysis. Rather than emphasizing specific sustainable-investing goals, it operates under the assumption that ESG should be considered when pursuing better risk-adjusted returns.
“Research suggests the use of positive screening or an integration approach has the greatest potential for improving risk-adjusted returns, but also is less likely to be harmful to returns than an exclusionary approach” Lazaroff said.
Some critics are quick to point out that ESG data is limited, non-standardized, and potentially skewed in favour of self-reporting companies. Lazaroff argued that companies are willingly providing more data, with studies suggesting that more transparent companies outperformed others in down markets.
“ESG potentially offers one more important benefit: It may help manage your own behavior,” he said. “If ESG investing provides an emotional attachment to your portfolio that makes you more likely to stick with investment for the long-haul, that’s a good thing in my book.”
