A Look at ESG (and an Alternative)
Seeking impact
What is important to you? As I serve clients, this question leads all discussions. It’s important to know the “why” behind our actions and decisions. It should be at the core of everything we do, not just financially.
It’s easy to imagine how the “why” helps guide us in most financial planning topics. For instance, when deciding on giving our children an education, personal values are typically present. Values also appear in legacy planning, estate planning, budgeting, among others. In other areas, however, the focus on values isn’t as apparent. Tax analysis, for example, doesn’t inspire many strong values discussions.
What about investing? Many investors see investment management as a rather cold, impersonal endeavor. A case can be made that very little matters more than volatility, return, and types of return when choosing investments. However, in recent decades, popularity has grown for a more values-driven form of investing. This has become known as ESG investing.
What is ESG investing?
The idea of choosing investments based on personally held values is an idea dating back to the 19th century. Back then, certain types of Protestants were encouraged to avoid investing in sinful products such as tobacco and alcohol. More recently, protests in the 1960s encouraged universities to divest in defense companies. Similarly, political pressure in the 1980s supported divesting from South African companies in an effort to end apartheid.
In tandem with political movements of the late 20th century, financial products began to appear to meet the emerging demand for values-aligned investing. In 1971, the Pax World Fund was registered, serving as the first investment vehicle with social and environmental awareness.
Finally, in 2004, the United Nations Global Compact coined the term ESG investing. The acronym stands for Environmental, Social, and Governance investing. Since then, ESG investing has exploded in popularity, serving all kinds of different value demands from investors. Today, there are lots of ESG options, but the shared focus of these funds is to measure the ethical and environmental impact of their investing activities.
Benefits of ESG
1) Sleep at night factor: When considering the benefits of ESG, probably the most important (and not often listed) consideration is what I call the “sleep factor.” Simply, this refers to your ability to achieve peace of mind with the investments you hold. I’m not talking about the return you’re achieving. It’s more about your conscience. If there is an industry you believe is harmful to the planet, I imagine you wouldn’t feel too good about owning their stock. If there is a country or region committing war crimes or treating their people unfairly, you may wish to invest your money elsewhere. These decision points are very intangible yet can feel very real to the person holding them. In the end, it is a personal preference; a preference in which the investor must find peace of mind.
2) Creating impact: This is the opposite of the sleep factor. While the sleep factor avoids negative aspects of industries or regions, this type of investing seeks positive versions. For example, should you believe in a certain type of energy development that will benefit the world, perhaps you could look for companies researching or using that type of energy. Similarly, if a company treats its employees and customers in an extraordinary way, you could use your investment dollars to support their efforts. This type of investing is a vote for, not against, certain values.
3) Aligning with values: If you’re someone who lives a very principled life in every regard, ESG investing provides the opportunity to bring your investing into the fold. It is a great option for those who seek virtue wherever they can find it.
4) Impact on companies/governments: As ESG grows in popularity, companies and governments are forced to acknowledge their effects. For this reason, entities can choose to improve their ethical and social impact on the world in an effort to appease and attract ESG investing dollars. Of course, the end result is that companies behave in a more ethical way, but ultimately the company must decide on these actions as a balance of ethics and its bottom line.
Cons of ESG
1) Lack of focus on return: Research is mixed on this one. Some research suggests ESG can outperform traditional investing. Some research shows no impact, while others point toward better downside protection. No matter who is right, the truth is that, since value and ethics are the primary decision points in ESG investing, 100% of the choice is not focused on returns.
2) Cost: Since ESG investing requires more research and discretion, ESG funds can have higher expense ratios associated with them. This is to compensate the managers and researchers who ensure the funds are aligned with their ethical intent.
3) Subjectivity: Even though an ESG fund may be focused on a particular ethical issue, the judgment of the fund manager may not agree with the opinions of an individual investor. Fund managers may exclude too many companies or not enough. Also, certain ESG factors may be considered on a different scale when compared to the feelings of investors.
“The main thing is to keep the main thing the main thing”
I love this phrase. Attributed to Steven Covey, this phrase highlights the importance of remembering what is important and our duty to keep it so. Ironically, you may believe this phrase supports the idea of ESG investing. If so, you have a point. After all, keeping core principles at the heart of your decisions is certainly “focusing on the main thing.”
However, it may surprise you that I don’t necessarily agree.
The right tool for the right job
When it comes to investment management, values and ethics do have a place. Primarily, your core values should be used to guide decisions when forming your ultimate goals. As mentioned, these goals could include education for children/grandchildren, building an inheritance to leave behind, and saving for large trips to see family or visits to bucket-list destinations. These decisions should be built around and directly reflect your core values. What matters most? That’s the question we use when forming these future goals.
But when it comes to investing to achieve these goals, we should turn our focus to finding the right tools to do so. That is, I believe it’s important to treat investing as a tool to achieve your values-aligned goals. Just as you pick the right tool to complete chores or tasks at work, using the right tool is important when pursuing financial goals.
Muddying the process
As we keep the main thing the main thing (i.e., our values-aligned goals), adding restrictions or requirements for the investments adds unnecessary complexity. This complexity not only comes with additional steps and costs, but it has the potential to detract from the ultimate goal. Of course, simple solutions may exist and those solutions may have the risk/return profile you desire, but you are still splitting your attention when it comes to forming goals and finding investments to support them.
You may argue that ESG investing is a way to support your values in a deeper way. This is the idea that you are doing everything you can to stay true ethically; however, remember that ESG investing can come with additional costs. Most critically, these costs may include falling short of the goal you formed in the first place. In this way, ESG investing could potentially turn from a broad values decision into cutting off your nose to spite your face.
Returning to the sleep factor
Recapping my logic above, I’m talking about creating value-aligned goals and picking the right investment tool to pursue them. And yes, to clarify, I’m implying that ESG investing causes unnecessary complexity when it comes to picking the right tool. But what about the sleep factor?
The sleep factor I discussed above is the most compelling reason to choose ESG investing. After all, you’re the one who has to live with your decisions and impact on the world. Pursuing goals is important, but selling your soul is no way to achieve them.
The impact of ESG
Before I offer an alternative, let’s take a moment to think about the ultimate impact of ESG.
Let’s imagine someone who strongly believes that the oil industry is harming the planet. This type of investor may be attracted to certain types of investment funds known as “fossil-free” or “low carbon.” Ideally, these types of funds would avoid the major oil producers.
Next let’s imagine an oil producer, ACME Oil, which is a major oil refiner in the US. Surely a fossil-free fund would not include ownership in ACME Oil. By purchasing a share of the fossil-free fund, a socially conscious investor would avoid ownership of ACME, ensuring their individual values were aligned with their investing decisions.
But let’s consider the impact of this decision. Yes, by avoiding the purchase of ACME Oil, less demand is placed on the price of the stock which in turn suppresses its value. While one investor won’t move the needle, thousands of investors definitely can. The net effect is that the stock may not rise in value as much as it otherwise could.
How does this affect ACME? As most publicly traded companies do, ACME probably holds a large amount of its own stock, known as “treasury shares.” If the price of the stock decreases or doesn’t rise as much as otherwise possible, the bottom line of the company is affected. Mission accomplished.
However, companies exist to make money and profits for their shareholders. Regardless of the image you have (or try to have) about companies, they exist to make money. ACME will continue in this effort. Every day thousands of employees will continue to strive to make a better product. Thousands of people will continue to purchase it. This will continue unencumbered, regardless of who and for what reason chooses not to own it. It may bring you peace of mind to not own ACME, but ACME (just like every other company) does not regard you much at all.
Finally, in an ironic twist, if the aggregated effort of socially minded investors does end up suppressing the stock price, then the Price-to-Earnings and Dividend Ratios actually end up improving. Both of these ratios are factors professional investors look for in companies.
The alternative
If you’ve read this far, then you are probably an investor with a conscience. You’re probably seeking a way to make a difference with your finances, or at least find peace investing in companies you don’t agree with. If so, I know I’ve popped your balloon. But instead of leaving it there, let’s look at how to better include values in your finances.
There is no better way to make a difference with your money than to give it freely to charities and organizations that support your values. The list here is endless. Environmental, social, advocacy in the public and private sector, disaster relief, illness research, academic support, and so on. The list is endless. Moreover, these charities’ ONLY purpose is to make the world better. They don’t seek these things along with making a profit. They only exist to serve their purpose. Now that is a direct impact.
So how should you square your conscience around owning companies you don’t agree with? Remember, these companies are going to continue to operate and make profits and share them with shareholders whether you own them or not. Can you think of a better impact than taking your share of profits from these companies and funneling them to charities of your choice? The profits will be shared with someone; might as well be with someone that will make something positive from them.
The right tool
Remember, always seek the right tool for the job. If the end result is important enough, then using the right tool is justified. Just remember not to muddle the process. You’ve chosen your goals for a reason and should seek every effort to achieve them. If the goal is important enough, then finding the right tool is important as well. Just remember to keep your values aligned with the end state in mind.
In the meantime, remember to get plenty of sleep.
"Pax World Funds." Wikipedia, The Free Encyclopedia, 12 July 2024, https://en.wikipedia.org/wiki/Pax_World_Funds. Accessed 14 March 2025. "United Nations Global Compact." Wikipedia, The Free Encyclopedia, 30 December 2024, https://en.wikipedia.org/wiki/UnitedNationsGlobal_Compact. Accessed 14 March 2025.
"Protests Against Dow Chemical During the Vietnam War." Michigan in the World, University of Michigan, https://michiganintheworld.history.lsa.umich.edu. Accessed 14 March 2025. "South Africa Apartheid Divestment Movement (1970s-1980s)." Global Nonviolent Action Database, Swarthmore Colege, https://nvdatabase.swarthmore.edu/content/south-africa-apartheid-divestment-movement-1970s-1980s. Accessed 14 March 2025.