A few weeks ago, over coffee, my colleagues and I we were discussing different points that we find important when selecting an instrument to invest in, and one topic that came up was “Ethical Investing” and ESG. Many people seem to use ethical investing and ESG interchangeably – when actually, they are not the same and investing in companies with a high E, S and G rating does not guarantee their ethical practices and vice versa.
If you’d like to read about how ESG ratings are used today, you can read it all about it here. In this article, I am going to focus on the differences between ESG investing and ethical investing and answer the question: “does a high ESG rating mean your investment is ethical?”
Many conflate the terms ESG investing and Ethical Investing, but in reality, they imply different strategies. Let’s go over some of the key differences between the two.
Ethical Investing: Also referred to as Socially Responsible Investing (SRI), ethical investing is a portfolio allocation strategy that is viewed as socially responsible due to the chosen nature of the company and its practices. This investment can come in the form of individual stocks, ETFs or mutual funds. Typically, ethical investing involves avoiding companies that sell addictive products or services, significantly damage the natural environment and/or have poor working standards and seeking out those engaged in the improvement of the natural and social environment. Investments of this nature tend to reflect the societal values and climate of the time and therefore come with the risk of the social climate shifting and the investment losing its appeal. On the other hand, ethical investments can be seen as less risky than others due to unlikelihood that they will face scandal or backlash from consumers because of their practices.
ESG Investing: a company’s ESG rating doesn’t necessarily have anything to do with its ethical practices. More so, it is a way to analyse risk beyond traditional financial metrics. Ratings are based on data points which quantify non-financial risk factors such as board and leadership structure, climate change and labour standards. Investors typically don’t rely solely on ESG information when looking at a potential investment, but rather integrate it into their overall research to get a more holistic view of a company.
So, does a high ESG rating indicate an ethical investment? To find out, I researched one of the most popular ESG ETFs, the ‘iShares ESG Aware MSCI USA ETF.’
According to BlackRock, the issuer of this ETF: “The iShares ESG Aware MSCI USA ETF seeks to track the investment results of an index composed of U.S. companies that have positive environmental, social and governance characteristics as identified by the index provider while exhibiting risk and return characteristics similar to those of the parent index.”
Of the ETFs 304 holdings, 15 of them were some of the world’s largest oil and gas producers including Exxon Mobil (#2), Chevron (#3) and ConocoPhillips (#7). Other notable holdings included Raytheon, the third largest weapons manufacturer in the world, Coca-Cola and PepsiCo, the #1 and #2 top plastic-polluting corporation, and Nike, a company that has consistently come under fire for their countless human rights violations such as child labour and unpaid wages for factory workers.
All of these companies have high ESG ratings since they have made commitments to look at changing their practices or reducing their waste. They have put in place the right processes and plans to mitigate the risks associated with these practices. While ESG ratings can be useful to understand a potential investment beyond the scope of traditional financial metrics, they do not indicate how ethical a company and its practices actually are.
With the above said, it’s important to note that looking at ESG ratings is important to understand the direction a company is going in, and that they are not mutually exclusive either. But the nuance of where are company is Vs where it would like to be is key to how to read these.
In order to make an investment that aligns with your moral views, thorough research must be done on the company and its practices to ensure that you are comfortable and confident with where you are allocating your money.
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