Concepts like “environmental, social and governance (ESG) investing” and “socially-responsible investing (SRI)” are becoming important in the investment process. A large number of market participants prefer to align their investment portfolios with their personal values. Therefore, today’s article discusses three factors to use when buying ESG stocks.
As early as 2004, representatives of the financial services industry and the United Nations (UN) published a report, titled “Who Cares Wins” and discussed the importance of ethical and socially responsible investing. Since then, interest in ESG investing has grown exponentially.
Recent metrics show, “The value of global assets applying environmental, social and governance data to drive investment decisions has almost doubled over four years, and more than tripled over eight years, to $40.5 trillion in 2020.”
Investors in the U.S., as well as worldwide, have different beliefs as individuals, ideologies as voters, preferences as consumers and objectives as investors. Therefore, picking the right ESG stocks may become a complex part of the investing process.
With that information, we take a closer look at three factors to use in ESG investing:
- Thematic ETFs
- Establishing investment objectives
- Revenue growth
ESG Investing: Thematic ETFs
ESG investing is a relatively new theme for most retail investors, who are likely to have different criteria to define and choose ESG stocks. For instance, some market participants may be careful about not buying the so-called sin stocks, such as shares of alcohol, tobacco, cannabis, firearms or gambling companies.
Other investors may prefer to buy ESG stocks that pay attention to human rights issues and environmental protection. And for others political issue may become a significant factor in ESG investing. Put another way, one size does not fit all.
Given the sheer number of companies to choose from, not only in the U.S. but also overseas, retail investors may find it easier to own ESG stocks via investing in thematic exchange-traded funds (ETFs).
There is no shortage of ETFs that have an ESG focus. Examples include the IQ Candriam ESG International Equity ETF (NYSEARCA:IQSI), the iShares ESG Aware MSCI EM ETF (NASDAQ:ESGE), the iShares MSCI Global Impact ETF (NASDAQ:SDG), Vanguard ESG US Stock Fund (NYSE:ESGV).
Understandably, investors would still need to study what is on offer by different funds, including trading history, annual returns, any dividends, expense ratios as well as holdings to decide if the fund fits with their ESG criteria and values.
Establishing Investment Objectives
Although ESG investing is increasing in importance, let’s not forget that it is an approach like others in portfolio construction. Retail investors must still be clear about their investment objectives and horizons before committing capital to ESG stocks or any other asset class.
Potential investors must also weigh the risk/return profile of investing in ESG stocks as opposed to investing in other themes or assets.
In retail portfolios, diversification across asset classes as well as different types of stocks is important for decreasing the overall volatility of a portfolio. For instance, in addition to buying ESG stocks, investors may also consider other assets, such as bond, commodities, currencies, or real estate.
For ESG investors, buying multi-asset ETFs could help in diversification. Examples of such funds are the Amplify High Income ETF (NYSEARCA:YYY), the First Trust Multi-Asset Diversified Income Index Fund (NASDAQ:MDIV), the WisdomTree 90/60 U.S. Balanced Fund (NYSEARCA:NTSX).
In addition, it would be equally important to diversify across other stocks with different focus. Several funds and themes to research further could be the Global X Robotics & Artificial Intelligence ETF (NASDAQ:BOTZ), the iShares Global Infrastructure ETF (NASDAQ:IGF), the Schwab US Large-Cap Growth ETF (NYSEARCA:SCHG), the Vanguard FTSE Developed Markets Index Fund ETF Shares (NYSEARCA:VEA), or the Vanguard S&P 500 ETF (NYSEARCA:VOO).
As we have so far discussed, investors increasingly pay attention to ESG factors when deciding on portfolio companies. However, if one of the objectives of the portfolio is capital growth, then investors want stocks that also have stable revenue growth.
Most analysts would regard revenue growth as one of the most important factors that affect the potential future stock price of a company. Without revenue, there would be no earnings or eventual profit.
Research by Narasimhan Jegadeesh of Emory University and Joshua Livnat New York University highlights, “The growing importance of revenues is due to the fact that they convey incremental information about future earnings growth.”
The authors continue, “Firms also recognize the importance of revenues to investors, and virtually all firms report revenues during their preliminary earnings releases. In contrast, far fewer firms report other balance sheet items, such the accounts receivables and inventory that are required to compute accruals and other financial ratios during preliminary earnings releases.”
Therefore, investors should ideally study a number of financial ratios in addition to the ESG criteria when deciding on these stocks. Stable revenue growth is crucial for winning stocks.
On the date of publication, Tezcan Gecgil did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tezcan Gecgil has worked in investment management for over two decades in the U.S. and U.K. In addition to formal higher education in the field, she has also completed all 3 levels of the Chartered Market Technician (CMT) examination. Her passion is for options trading based on technical analysis of fundamentally strong companies. She especially enjoys setting up weekly covered calls for income generation.