Investors should consider the diversification benefits of socially responsible investments and how they can enhance a core portfolio position through ESG exchange traded fund strategies.

In the recent webcast, Sustainable Strategies to Add to Portfolios in 2020, Sean Edkins, Head of ETF Sales and Strategic Partnerships, DWS; Gerold Koch, Product Development ESG and Index Investing, DWS; and Robert G. Smith, President and Chief Investment Officer, Principal, Sage Advisory, defined socially responsible investments that incorporate environmental, social and governance principles to help investors better diversify their core portfolios.

The strategists explained that socially responsible investing covers more than just environmental aspects like climate change, protection of natural resources, pollution and ecological opportunities. It also includes social and governance factors as well.

Specifically, they explained that the social aspect includes health and safety, product liability and the supply chain. For example, an ESG strategy can look to supply chain issues to make sure companies are using sustainable practices there and that they are not obtaining items from too questionable of sources or regimes. It can cover how employees are being treated and product liability concerns too. These items can definitely play a role in a company’s well-being or reputation over the long term.

Lastly, the governance principle is based on corporate governance and corporate behavior, or how companies are owned, the pay and board structures, and then general business ethics. These non-financial factors can often have a financial impact.

There has been a growing voice for socially responsible investments to be included in a diversified portfolio. Specifically, there is an increasing recognition within the financial community that argue ESG factors play a material role in determining risk and returns. There is also greater demand from beneficiaries and investors for greater transparency on how and where money is invested. Furthermore, the strategists argued that higher levels of regulatory guidance that incorporate ESG factors is part of an investor’s fiduciary duty to clients and beneficiaries. Consequently, we have seen total U.S.–domiciled assets under management using sustainable investing strategies expanded to $12.0 trillion at the start of 2018 from $8.7 trillion at 2016, or a 38% increase.

Wealth and demographic shifts may also contribute to growing interest for ESG investments, notably the rising income and wealth among the millennial and women groups. Millennials could have net worth in the $20 trillion range and 90% of millennials have shown intentions to allocate to responsible investments over the next five years. Additionally, $30 trillion is expected to pass from baby boomers to millennials over the next two to three decades. Meanwhile, female investors are twice as likely as their male counterparts to consider sustainability alongside return when investing.

As a way to incorporate ESG investments into a diversified portfolio, investors need not give up core allocations since ESG investments can overlap with these traditional market exposures. While ESG investments have not experienced the same booms as traditional growth stocks, companies that follow ESG principles have exhibited smaller swings that could help investors capture improved risk-adjusted returns over the long haul.

The ESG theme is not some fringe or niche investment that is relegated to a satellite portfolio position. Over one-quarter of assets under management globally, or more than $22 trillion, are now being invested according to the premise that environmental, social and governance factors can materially affect a company’s performance and market value. ESG integration has been growing at 17% per year.

Investors do not need to give up anything to maintain a socially responsible investment portfolio. In fact, academic research has revealed strong evidence that environmental, social and governance factors positively influence corporate valuation and investment performance. Looking at over 2,000 academic ESG performance studies, DWS has found 90% of results demonstrate that prudent sustainability practices have a positive or neutral influence on investment performance, 88% of companies with robust sustainability practices demonstrate better operational performance and cashflows, nine of the GICS Sectors saw stocks with superior ESG scores signal lower earnings volatility, and companies with high ESG ratings tend to have a lower cost of capital.

To help investors diversify with the ESG theme, DWS has come out with a suite of ESG ETFs, including the Xtrackers MSCI EAFE ESG Leaders Equity ETF (NYSEArca: EASG), Xtrackers MSCI Emerging Markets ESG Leaders Equity ETF (NYSEArca: EMSG) and Xtrackers MSCI ACWI ex USA ESG Leaders Equity ETF (NYSEArca: ACSG). Additionally, the more recently launched Xtrackers S&P 500 ESG ETF (SNPE) is among the first ETFs to track the S&P 500 ESG Index, the environmental, social and governance derivative of the widely followed S&P 500 Index.

Financial advisors who are interested in learning more about sustainable investment strategies can watch the webcast here on demand.