Investment strategies and exchange traded funds that target environmental, social and governance, or ESG, principles could be a growing theme for 2016.
“These trends reflect a softening economy, a long-term shift to a low carbon economy, a generational changeover, and institutional forces,” writes Linda-Eling Lee, Global Head of ESG Research at MSCI, for FactSet.
Investors can target companies with a socially responsible mindset through ETFs, including the iShares MSCI USA ESG Select Social Index Fund (NYSEArca: KLD) and iShares MSCI KLD 400 Social ETF (NYSEArca: DSI), which provide broad exposure to companies with socially responsible characteristics.
KLD and DSI both include stocks with strong environmental, social, and governance records in areas that are relevant to their industries, including carbon emissions, labor management and corporate governance. KLD, though, excludes companies operating in the weapons, alcohol, gambling, nuclear power, adult entertainment and genetically modified organisms industries.
Investors seeking to invest in companies that have a smaller impact on the global environment would typically follow characteristics described under sound ESG principles. Retail investors interested in ESG investments can also look at the SPDR MSCI ACWI Low Carbon Target ETF (NYSEArca: LOWC) and the iShares MSCI ACWI Low Carbon Target ETF (NYSEArca: CRBN) for more socially responsible strategies.
LOWC and CRBN both target the MSCI ACWI Low Carbon Target Index, which tries to address carbon exposure by overweighting companies with low carbon emissions relative to sales and per dollar of market capitalization, compared to the broader market. Both ETFs were created for the U.N. Joint Staff Pension Fund.
Academic research reveal that strong governance mechanisms have helped diminish default risk and lower bond yields. Barclays also recently discovered that investment-grade bonds with higher ESG scores outperformed those with low ESG scores over the past 8 years.
Following the Paris climate agreement, institutional investors and retail investors are beginning to show greater interest in aligning portfolio exposure to a low carbon economy.
Consequently, “in 2016, we may see utilities increasingly spin off renewable assets from legacy generation assets as investors seek exposure to the low carbon energy assets of the future,” Lee said.
For instance, with a new generation of investors, the younger demographics are more apt to favor companies that address to social and environmental responsibilities. These investors will also be prone invest in companies that follow ESG principles as a way to align investment goals with their individual values and philosophies.
More recently, even large pension funds have banded together to pressure industries into fundamental changes. For instance, some large state pensions have dropped coal and energy companies in favor of more environmentally friendly investments. Pension funds have also pushed for changes in boardrooms and targeted governance problems in individual companies.
Max Chen contributed to this article.