In recent years, interest in ESG (Environmental, Social, and Governance) investing has grown exponentially. Once a niche strategy, this approach to investing has become so popular that today, over 80% of investors are pursuing or considering ESG-related investment strategies.
So, what is it about ESG investing that is so appealing? And how can eToro investors incorporate ESG leaders into their investment portfolios today?
What is ESG Investing?
Before we explore why ESG investing is capturing the attention of investors, let’s take a quick look at what it actually is.
ESG investing, or “sustainable investing” as it is sometimes called, is a form of socially responsible investing that involves assessing companies according to environmental, social, and governance criteria. The aim of this approach to investing is to generate a financial return by investing in companies that respect and look after the environment, care about human wellbeing, and commit to responsible corporate behaviour.
To assess a company according to ESG criteria, investors look at a broad range of factors. The environmental component focuses on how the company affects the planet through its use of energy, its pollution and waste, and its natural resource conservation. The social part addresses the company’s business relationships, and looks at issues such as employee diversity, labour standards, and customer satisfaction. Meanwhile, the governance component looks at how a company is run, and considers board composition, leadership effectiveness, and business ethics.
Often, investors rely on “ESG ratings” or “ESG scores” when investing with an ESG focus. These ratings — which are provided by financial data specialists and are now available on the eToro platform — measure a company’s exposure to ESG risks. A high ESG rating means that the company is managing its environmental, social, and governance risks well — relative to its peers. In contrast, a low rating means that the company has relatively high ESG risks compared to its peers. Using these ratings, investors can objectively assess the ESG performance of a business and make better-informed investment decisions.
Why ESG investing is so appealing
As for why ESG investing has become so popular, much can be attributed to the growing awareness of the importance of protecting the environment. This has resulted in a big shift towards sustainable investment strategies.
No longer are investors only interested in generating financial gains from their investments. Instead, they want their money to go into companies that operate responsibly, think about the environment, and provide sustainable goods and services. In the same way that sustainability now plays a major role in consumers’ purchasing decisions (many consumers are willing to pay more for sustainable goods), it is also playing a key role in investors’ decisions.
This interest in protecting the environment is particularly prevalent among young investors. According to Morgan Stanley, 99% of millennial investors are interested in sustainable investing.
ESG leaders produce higher investment returns
Another reason that this style of investing has become popular is that research has shown that strategies focused on ESG leaders tend to generate strong returns for investors in the long run.
Companies that have high ESG scores are typically well-managed businesses that address their environmental challenges, treat their stakeholders well, and have lower levels of controversies. These businesses tend to generate higher operating margins and returns on capital over time than low-rated ESG companies, along with higher levels of dividend growth, which, in turn, leads to higher long-term returns for investors.
It is worth pointing out that there is a bit of a feedback loop at play here. Good ESG initiatives drive up financial performance, and this can provide the monetary resources to reinvest, and do even better on the ESG front. This reinvestment then drives business performance up further, and so on.
Low-rated ESG firms, on the other hand, face a myriad of challenges that can limit investment performance. For example, businesses involved in environmental controversies can face higher costs due to regulatory issues, and customers may avoid them, lowering revenue. Meanwhile, if a company does not treat its employees fairly, this can lower morale, leading to increased turnover and lower productivity. Investors may also choose not to invest in a business that scores poorly on the ESG front, thereby, limiting its access to capital. All of these issues can have a negative impact on a company’s share price.
High ESG leads to low volatility
The stocks of companies that score well in terms of ESG also tend to be less volatile than those of companies that score poorly. This was demonstrated during the COVID-19 pandemic. Research from S&P Global Market Intelligence shows that in the first 12 months of the pandemic, many ESG-focused funds outperformed the broader market. Meanwhile, research from Morgan Stanley shows that when markets were volatile in 2008, 2009, 2015, and 2018, sustainable funds consistently exhibited less downside than traditional investment funds. This lower level of volatility — which can be attributed to ESG leaders’ focus on risk — can also help boost investment returns.
eToro’s new ESG-Leaders Smart Portfolio
To help investors gain exposure to ESG investments, eToro recently launched the ESG-Leaders Smart Portfolio. This is a fully allocated diversified portfolio, equally weighted across 11 different industry sectors, focusing on companies with high ESG ratings.
Stocks selected for this Smart Portfolio have some of the highest ESG scores in their industry sector. Stocks undergo a screening process based on a number of metrics, including market capitalisation, liquidity, financial ratios, and analyst consensus ratings. The end result is four stocks from every industry sector, totaling 44 stocks with high ESG ratings.
Some examples of stocks in the portfolio at present include cloud computing specialist Snowflake, chip powerhouse Nvidia, robotic surgery company Intuitive Surgical, sportswear company Lululemon Athletica, and consumer health giant Colgate-Palmolive. All of these companies score well on the ESG front.
You can find out more about eToro’s new ESG-Leaders Smart Portfolio here.
eToro is a multi-asset investment platform. Copy Trading does not amount to investment advice. The value of your investments may go up or down. Your capital is at risk.
1https://www.morganstanley.com/press-releases/morgan-stanley-survey-finds-sustainable-investing-momentum-high-
2https://sustainfi.com/articles/investing/esg-statistics
3https://www.morningstar.co.uk/uk/news/214249/do-esg-stocks-outperform.aspx
4https://www.morganstanley.com/content/dam/msdotcom/ideas/sustainable-investing-offers-financial-performance-lowered-risk/Sustainable_Reality_Analyzing_Risk_and_Returns_of_Sustainable_Funds.pdf
This communication is for information and education purposes only and should not be taken as investment advice, a personal recommendation, or an offer of, or solicitation to buy or sell, any financial instruments. This material has been prepared without taking into account any particular recipient’s investment objectives or financial situation, and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past or future performance of a financial instrument, index or a packaged investment product are not, and should not be taken as, a reliable indicator of future results. eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this publication.