As more investors look to ESG investing strategies, one should compare how it is different from Socially Responsible Investing or Impact Investing and consider an exchange traded fund strategy to effectively integrate ESG into a diversified portfolio.
In the recent webcast, ESG: Investing for Good or for Performance. Why Not Both?, David Mazza, Managing Director, Product, Direxion, explained that ESG investing has taken shape to be a more inclusionary means of identifying firms that are incorporating various positive practices aligned with Environmental, Social, and Governance issues into their business. In comparison, traditional socially responsible investments were the primary term used to define responsible investing principles, but the majority of the approaches were more exclusionary or removed large parts of the investment landscape.
When covering ESG investments, the environmental aspect includes attributes like climate change, natural resources, pollution, waste management, and other environmental opportunities. The social aspect incorporates human capital, product liability, stakeholder opposition, and other social opportunities. Lastly, the governance aspect covers things like corporate governance and corporate behavior.
At MSCI, the index has created a rules-based rating methodology to help identify industry leaders and laggards on a scale similar to bond ratings.
“Global sustainability challenges such as flood risk and sea-level rise, privacy and data security, demographic shifts, and regulatory pressures, are introducing new risk factors for investors that may not have been seen previously. As companies face rising complexity on a global scale, the modern investor may reevaluate traditional investment approaches,” Mazza said.
Mazza also highlighted the changing investor demographics with a growing millennial group and the younger generation’s preferences, compared to older investors. About $30 trillion will be transferred from baby boomers to the 75 million millennials over the next few decades. This will also market a significant shift in investment preferences as 77% of millennials cite owning ESG or including impact investments in their portfolios. About 57% of millennials have stopped investing or declined to invest in a company due to the impact that of that company’s products or services on people’s health and well being.
ESG is also more than a feel-good investment strategy. Mazza underscored studies that suggest companies with more robust ESG practices can display the lower cost of capital structures and lower volatility while companies that performed poorly on ESG showed some of the opposite characteristics.
Furthermore, companies with good ESG scores may also further diversify risk in a portfolio. The highest-ranked ESG companies have lower volatility than does the lowest-ranked ESG companies. Mazza argued this may indicate that highly ranked ESG could systematically be of higher quality relative to the worst ones as high profitability means that a company may have competitive advantages relative to their peers.
As a way to tap into the ESG theme, investors can utilize the recently launched Direxion MSCI USA ESG – Leaders vs. Laggards ETF (Ticker: ESNG), which delivers a unique approach to ESG investing that is long and overweight companies with high ESG ratings and is also short those with low ESG ratings. The investment strategy could provide investors a more complete view of both the leaders and laggards in ESG issues within the MSCI USA universe.
The underlying The MSCI USA ESG Universal Top – Bottom 150/50 Return Spread Index methodology uses an ESG score that combines ESG rating with the ESG trend, which offers a differentiated approach to ESG integration.
“The top ESG companies have larger market capitalizations, less debt, and greater profitability than does the market. On the other hand, bottom ESG companies have smaller market caps, greater debt, and worse profitability than the market,” Mazza added.
Financial advisors who are interested in learning more about ESG-related strategies can watch the webcast here on demand.