Woke Investing: What Is the ESG Strategy and Is It Effective?

Every investor has a strategy. It could be as simple as 'buy low, sell high' or involve complex formulas filled with greek letters. ESG strategy is an impact-conscious investment style involving public companies with environmentally and socially responsible business practices and the ESG trend blew up over the past several years.

The main rationale behind ESG is that companies can create more value by promoting corporate governance and prioritizing environmental and social concerns over the interests of shareholders. Money has poured into ESG investments as climate change awareness grew and consumers put greater emphasis on corporate social responsibility. Despite their brief track record, ESG investments have performed well on the stock market and could continue doing so into the future.

Why ESG works

Companies that incorporate environmental impact goals into their business strategies are likely to outperform those that don't. With regulations around greenhouse gas emissions increasing, companies that don't embrace sustainable energy will be at a disadvantage. Ethical business practices are also crucial because they improve employee productivity and, along with green energy, can reduce the impact of legal or regulatory intervention. Overall, an ESG business strategy can help a company be more profitable by cutting costs and raising efficiency.

The case against ESG

The argument against ESG strategies is that ESG initiatives are corporate activism and that socially responsible investments aren't necessarily more profitable. Rather than promoting corporate social responsibility, ESG strategies arbitrarily limit investors' opportunities. For instance, many ESG funds don't invest in businesses involving alcohol, cannabis, tobacco, gambling, weapons, fossil fuels, and more—profitable industries that are simply incompatible with ESG objectives due to particular legal, ethical, or environmental implications.

Detractors of ESG also observe that there is no meaningful metric for evaluating if a business meets environmental, social, and governance criteria. This means it's hard to determine if a company has the ESG rating it deserves and practices what it preaches. The lack of ESG data makes it a problem for funds to determine the environmental or social impacts of their investments. More comprehensive measurements could transform the ESG trend into a respected discipline. 

ESG stocks 

ESG initiatives have led many publicly traded companies to adopt principles and business practices to address environmental, social, and governance responsibilities. For example, high-value companies like Nvidia (NVDA), Microsoft (MSFT), and Apple (APPL) have set environmental, social, and governance criteria for their respective business operations. Corporations that set ESG criteria suddenly got stamps of approval from Vanguard funds and other institutional investors that employ an ESG strategy.

Large companies that display strong corporate governance often attract institutional capital because their businesses are likely to be more compliant and adaptable to change. This also indicates that the company can adhere to other ESG principles which are expected to translate to value creation and, thus, greater investment returns for shareholders. Things like offsetting carbon emissions, boosting supply chain efficiency, and generating positive social impact are all correlated with greater value creation.

ESG ETFs

The best ESG stocks are popular Big Tech companies like Amazon (AMZN), Meta Platforms (META), and Tesla (TSLA), but determining which small stocks follow ESG criteria can be difficult. Finding hidden gem ESG stocks is a challenge, so it's easier to make impact-conscious investments by buying an ESG strategy fund like ESGV. This Vanguard ESG fund only buys shares in U.S. companies that follow the UN Global Compact Principles, meet diversity criteria, and are not related to certain industries.

ESGV is the best ESG ETF because of its low expense ratio and strong overall performance, but other funds can be added to an ESG strategy portfolio. Comparable ESG funds also offered by Vanguard include VFTAX and VEIGX. Otherwise, iShares Global Clean Energy (ICLN) is an example of an industry-specific ESG ETF that investors can hold for exposure to the global green energy market. Since many ESG ETFs have high allocations in large-cap tech stocks, investing in industry-specific ETFs could help hedge against risk.

Investing against ESG

The adoption of ESG business practices was largely due to impact-conscious stakeholders demanding that companies follow the criteria. While the ESG strategy was embraced by most institutional investors, some investors view ESG as part of a global corporate agenda to inject social and political issues into matters of economics and business. Investors who are against ESG or want to bet against corporate activism certainly have options.

The easiest way to invest against ESG is by investing in agricultural ETFs and other things that don't follow such stringent standards. Most ESG ETFs don't invest in businesses involved in gambling, drugs, and alcohol, but you can bet on all three industries with the BAD ETF. BAD consists of equal amounts of U.S. companies in the three market segments of betting, pharma, and alcohol (including cannabis), and many of its holdings don't have ESG objectives. 

Another anti-ESG ETF that could be made available soon is the God Bless America ETF (YALL). YALL is a fund that seeks to invest in companies that create American jobs and screens for ones that emphasize political activism and social agendas at the expense of shareholder returns. If you're skeptical about ESG funds and can put your money where your mouth is, keep an eye out for ETFs that eschew any social message.

The ESG strategy has seen massive growth in popularity over the past few years, but following social and environmental criteria doesn't necessarily make something a better investment. Whether you believe in ESG investing or you want your portfolio to reflect your skepticism, the best place to start buying stocks and ETFs is Robinhood.

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