I know that some of you are on board with ESG investing. And I also know that some of you might think that it is bunk. For me, it is truly not about politics, but rather what works well in the stock and bond markets now.
I have read, listened to and had the tremendous privilege of meeting Dr. Milton Friedman. He was the Nobel Prize winning economist that was predominately at the University of Chicago. He was an ardent supporter of the free market. And while ESG was not yet a common investment phrase — he was critical of companies that took efforts toward causes other than shareholder returns. He thought that doing so made companies less productive and profitable.
But even Uncle Milton would now agree that today, the market-driven forces are justifying investment in ESG right now.
ESG investing stands for environmental, social and governance. And it is both a category of companies as well as a scoring mechanism of companies. The basic nature of ESG is that it is a means of investing that will not only provide growth and income, but one that has a better impact on the environment, society and shareholders.
Beyond the Basics of ESG Investing
But what does ESG really mean? How should you conceptualize each of the components?
Environmentally friendly means greater use or production of clean energy along with less impact in terms of waste and material use. This is not a drag on most companies –including energy and utility companies — that continue to drive growth and more income from renewable and cleaner energy production.
Social concerns bring in the practice of involving more stakeholders into the decisions of companies. It means that companies are more aware of the impact on communities as well as consumers. It can be a grab bag for lots of other causes — but at its core — social responsibility should drive consumers to have a more favorable view of a company.
Governance includes better recognition of shareholders’ rights. This means independent boards of directors, more transparency in executive compensation and greater disclosure of company activities and financial conditions. All of this I have always been in favor of — including having separate CEO and chairman positions. I am also a fan of greater disclosure throughout the year and in quarterly reports.
Investors Are Now Demanding ESG
Individual investors are still a smaller part of the stock and bond market in their direct investments. Institutional investors continue to dominate in activities and holdings. And while many institutions are run privately for the benefit of their founders, more are run for the benefit of different cohorts.
Think pension funds or endowments, which make up a large portion of the capital market in the U.S. and beyond. The beneficiaries of these funds are demanding that fund management invest more in ESG-compliant or ESG-focused companies. And historically, beneficiaries have had a large sway on fund management when it comes to several targeted issues or agendas.
This is bringing the concept of ESG investing further into the boardrooms and C-Suites of companies. Additionally, fund managers are directing more capital to ESG-friendly companies.
BlackRock (NYSE:BLK), a stock in a dividend-focused portfolio within Profitable Investing called the Incredible Dividend Machine, has been making larger investments in ESG. Larry Fink, the founder and CEO of the company, is a big proponent of ESG. He has led the asset management company to roll out a series of funds including a major initiative in its dominating exchange-traded fund collection.
And the ESG market has been showing good performance. The S&P ESG Index has returned 214.4% over the trailing 10 years.
S&P ESG Index Total Return
And over the past trailing year the ESG index has outperformed the S&P 500 by 18.8% in better total return. This shows that ESG can be more defensive or reliable and may well attract more capital than the general stock market going forward.
S&P ESG and S&P 500 Indices Total Return
How to Pick the Right Stocks and ETFs for ESG Investing
Now, ESG compliance is a squiggly bit of analysis. On my Bloomberg Terminal there is a function that takes a lot of compiled data and comes up with all sorts of embedded ESG criteria. This means that even a petrol royalty company such as a favored Viper Energy (NASDAQ:VNOM), the landlord of the Permian Basin inside my Profitable Investing, is not negatively rated overall in its ESG analysis.
So, ESG compliance can be achieved across industries at some level. But I want to direct your attention to three companies firmly leading in the ESG green energy space and then direct your attention to three ETFs in the general ESG markets that are all great opportunities right now.
- NextEra Energy (NYSE:NEE)
- Xcel Energy (NYSE:XEL)
- Hannon Armstrong Sustainable Infrastructure (NYSE:HASI)
- Vanguard ESG U.S. Stock ETF (BATS:ESGV)
- iShares ESG U.S. Aggregate Bond ETF (NYSEARCA:EAGG)
- iShares ESG USD Corporate Bond ETF (NASDAQ:SUSC)
ESG Investing: NextEra Energy (NEE)
I want to start first with the utility market. This is a space where successful companies are embracing renewable energy. Government incentives led many utilities to enter and expand in renewable energy. State and local governments have also been mandating the increasing use of renewable energy as a percentage of power generation.
This has led the poster child of the ESG utility market, NextEra Energy, to really perform. NextEra Energy is one of the largest wind and solar power companies in the world. It has deployed renewable energy in its regulated market in Florida and has expanded around the nation and beyond in its unregulated business.
The stock has generated a return since being added to the Total Return Portfolio of Profitable Investing of 629.1%. For the trailing year it has returned 31.3% — which is well above the return of the S&P 500.
NextEra Energy Stock Price
Yielding 2%, NextEra Energy is an ESG buy in a tax-free account.
Xcel Energy (XEL)
Following the playbook of NextEra is Excel Energy. It increasingly is deploying renewable energy generation in its regulated markets — and more so for its national unregulated business that serves nearly 4 million customers.
Xcel Energy Stock Price
Over the past five years alone it has generated a return for shareholders of 147.2%, which is nearly double the return of the S&P 500. And it has continued this in 2020 with a positive return of 13.7% that again is beating the S&P 500.
Yielding 2.4% with its recently affirmed dividend, it is another ESG buy in a tax-free account.
Hannon Armstrong Sustainable Infrastructure (HASI)
But perhaps one of the best ESG opportunities right now is Hannon Armstrong Sustainable Infrastructure Capital. Hannon Armstrong provides financing for renewable energy and related projects.
The first thing investors should know is that Hannon Armstrong has the structure of a REIT. Why? It is associated with all of the real estate of its financed projects. This REIT structure helps it avoid corporate income tax and provides it more cash to use for dividends. And thanks to the Tax Cuts & Jobs Act of 2017, the dividends come with a 20% deduction at tax time.
Hannon Armstrong Sustainable Infrastructure Capital Stock Price
But what makes the company even better as a shareholder is that its financed projects come with government guarantees. This provides a back-stop for the company and shareholders. In the current economy, this is incredibly attractive, if not vital.
Since I added HASI stock to my portfolio at the end of 2019 it has returned 30.7%. And since the general stock market low in March, shares are really powering up for a very green return of 128.5%.
And with more ESG-seeking investors, I see this company gaining attention. It is still a value as the stock trades at a mere 2.55 times its intrinsic book value, which is cheap for a REIT. Yielding 3.3% it is a buy in a taxable account.
ESG Investing: ESG U.S. Stock ETF (ESGV)
Now, if you want to just dip your toe into the cleaner waters of ESG investing, one of the easiest ways is to go with a synthetic ETF. On the stock front is an ETF put together by Vanguard. Start with its ESG U.S. Stock ETF.
ESGV pays a fee to the Financial Times Stock Exchange Group (FTSE) to synthetically track its index of U.S. stocks that have technology as a heavy-weighted segment. It also tracks stocks in healthcare, finance and other segments.
Vanguard ESG U.S. Stock ETF and S&P 500 Index Total Return
Since coming to the market in September 2018 it has returned 26.7% which is well ahead of the general S&P 500 for the same time period.
Yielding 1.3% it is a buy in a tax-free account.
iShares ESG Aware U.S. Aggregate Bond ETF (EAGG) and iShares ESG Aware USD Corporate Bond ETF (SUSC)
Then in ESG bonds — now more commonly referred to as “green bonds” — the market is really heating up with heavy demand from institutional investors. Issuers are now moving quickly to meet that demand with new green bonds.
Simply put, green bonds are used to fund ESG initiatives. They come from both governments and corporations. There are now a series of ETFs that are working with Bloomberg Barclays bond indices for the overall U.S. aggregate bond market as well as U.S. corporations that are ESG scoring.
iShares ESG Aware U.S. Aggregate & iShares ESG Aware U.S. Corporate ETFs Total Return
BlackRock is a big leader in ESG investing. And its iShares ETF unit has two leading investments in its iShares ESG Aware U.S. Aggregate Bond ETF and its iShares ESG Aware USD Corporate Bond ETF.
Since coming to the market, both of the ETFs have generated impressive yield and price gains. EAGG has returned 19.1% and SUSC has returned 23.8%.
With EAGG yielding 1.4% and SUSC yielding 1.97%, they are both buys in tax-free accounts.
On the date of publication, Neil George did not hold (either directly or indirectly) any positions in the securities mentioned in this article.
As the editor of Profitable Investing, Neil George helps long-term investors achieve their growth and income goals with less risk. With 30-plus years of experience in the financial markets, Neil recommends undiscovered and underappreciated companies that offer subscribers double-digit yields now and triple-digit returns over time.